SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended October 2, 2005
Commission File Number 0-9286
COCA-COLA BOTTLING CO. CONSOLIDATED
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or
organization)
4100 Coca-Cola Plaza, Charlotte, North Carolina 28211
(Address of principal executive offices) (Zip Code)
(704) 557-4400
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding at October 31, 2005
Common Stock, $1.00 Par Value
Class B Common Stock, $1.00 Par Value
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED OCTOBER 2, 2005
INDEX
PART I – FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
PART II – OTHER INFORMATION
Item 6.
2
PART I - FINANCIAL INFORMATION
Coca-Cola Bottling Co. Consolidated
CONSOLIDATED BALANCE SHEETS
In Thousands (Except Share Data)
Unaudited
Oct. 2,
2005
Jan. 2,
Sept. 26,
2004
ASSETS
Current Assets:
Cash
Accounts receivable, trade, less allowance for doubtful accountsof $1,364, $1,678 and $1,964
Accounts receivable from The Coca-Cola Company
Accounts receivable, other
Inventories
Prepaid expenses and other current assets
Total current assets
Property, plant and equipment, net
Leased property under capital leases, net
Other assets
Franchise rights, net
Goodwill, net
Other identifiable intangible assets, net
Total
See Accompanying Notes to Consolidated Financial Statements
3
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Portion of long-term debt payable within one year
Current portion of obligations under capital leases
Accounts payable, trade
Accounts payable to The Coca-Cola Company
Accrued compensation
Other accrued liabilities
Accrued interest payable
Total current liabilities
Deferred income taxes
Pension and postretirement benefit obligations
Other liabilities
Obligations under capital leases
Long-term debt
Total liabilities
Commitments and Contingencies (Note 14)
Minority interest
Stockholders’ Equity:
Common Stock, $1.00 par value:
Authorized - 30,000,000 shares;
Issued - 9,705,451, 9,704,951 and 9,704,951 shares
Class B Common Stock, $1.00 par value:
Authorized - 10,000,000 shares;
Issued - 3,068,366, 3,048,866 and 3,048,866 shares
Capital in excess of par value
Retained earnings
Accumulated other comprehensive loss
Less-Treasury stock, at cost:
Common - 3,062,374 shares
Class B Common - 628,114 shares
Total stockholders’ equity
4
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
In Thousands (Except Per Share Data)
Net sales
Cost of sales, excluding depreciation expense shown below
Gross margin
Selling, delivery and administrative expenses, excluding depreciation shown below
Depreciation expense
Amortization of intangibles
Income from operations
Interest expense
Income before income taxes
Income taxes
Net income
Basic net income per share
Diluted net income per share
Weighted average number of common shares outstanding
Weighted average number of common shares outstanding-assuming dilution
Cash dividends per share
Common Stock
Class B Common Stock
5
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
In Thousands
Balance on Dec. 28, 2003
Comprehensive income:
Net gain on derivatives, net of tax
Total comprehensive income
Cash dividends paid
Common ($.75 per share)
Class B Common ($.75 per share)
Issuance of 20,000 shares ofClass B Common Stock
Balance on Sept. 26, 2004
Balance on Jan. 2, 2005
Conversion of Class B Common Stock into Common Stock
Balance on Oct. 2, 2005
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Cash Flows from Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Losses on sale of property, plant and equipment
Amortization of debt costs
Amortization of deferred gain related to terminated interest rate agreements
Decrease in current assets less current liabilities
(Increase) decrease in other noncurrent assets
Increase (decrease) in other noncurrent liabilities
Other
Total adjustments
Net cash provided by operating activities
Cash Flows from Financing Activities
Payment of long-term debt
Payment of current portion of long-term debt
Repayment of lines of credit, net
Principal payments on capital lease obligations
Premium on exchange of long-term debt
Net cash used in financing activities
Cash Flows from Investing Activities
Additions to property, plant and equipment
Proceeds from the sale of property, plant and equipment
Proceeds from the redemption of life insurance policies
Net cash used in investing activities
Net increase (decrease) in cash
Cash at beginning of period
Cash at end of period
Significant non-cash investing and financing activities:
Issuance of Class B Common Stock related to stock award
Capital lease obligations incurred
Exchange of long-term debt
7
Notes to Consolidated Financial Statements (Unaudited)
1. Accounting Policies
The consolidated financial statements include the accounts of Coca-Cola Bottling Co. Consolidated and its majority owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated.
The consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results for the interim periods presented. All such adjustments are of a normal, recurring nature.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The accounting policies followed in the presentation of interim financial results are consistent with those followed on an annual basis. These policies are presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form
10-K for the year ended January 2, 2005 filed with the Securities and Exchange Commission.
Certain prior year amounts have been reclassified to conform to current year classifications.
2. Seasonality of Operations
Operating results for the third quarter and the first nine months of 2005 are not indicative of results that may be expected for the fiscal year ending January 1, 2006 because of business seasonality. Business seasonality results primarily from higher unit sales of the Company’s products in the second and third quarters versus the first and fourth quarters of the fiscal year. Fixed costs, such as depreciation, amortization and interest expense, are not significantly impacted by business seasonality.
3. Piedmont Coca-Cola Bottling Partnership
On July 2, 1993, the Company and The Coca-Cola Company formed Piedmont Coca-Cola Bottling Partnership (“Piedmont”) to distribute and market nonalcoholic beverages primarily in portions of North Carolina and South Carolina. The Company provides a portion of the finished products to Piedmont at cost and receives a fee for managing the business of Piedmont pursuant to a management agreement.
Minority interest as of October 2, 2005, January 2, 2005 and September 26, 2004 represents the portion of Piedmont owned by The Coca-Cola Company, which was 22.7% for all periods presented.
8
4. Inventories
Inventories were summarized as follows:
Finished products
Manufacturing materials
Plastic shells, plastic pallets and other
Total inventories
5. Property, Plant and Equipment
The principal categories and estimated useful lives of property, plant and equipment were as follows:
Estimated
Useful Lives
Land
Buildings
Machinery and equipment
Transportation equipment
Furniture and fixtures
Cold drink dispensing equipment
Leasehold and land improvements
Software for internal use
Construction in progress
Total property, plant and equipment, at cost
Less: Accumulated depreciation and amortization
6. Leased Property Under Capital Leases
Leased property under capital leases was summarized as follows:
EstimatedUseful Lives
Leased property under capital leases
Less: Accumulated amortization
The majority of the leased property under capital leases is real estate and is provided by related parties as described in Note 19 to the consolidated financial statements.
9
7. Franchise Rights and Goodwill
Franchise rights and goodwill were summarized as follows:
Franchise rights
Goodwill
Franchise rights and goodwill
Franchise rights and goodwill, net
The Company performed its annual impairment test of franchise rights and goodwill during the third quarter of 2005. As of October 2, 2005, there was no impairment of the carrying values of franchise rights and goodwill.
8. Other Identifiable Intangible Assets
Other identifiable intangible assets were summarized as follows:
Customer relationships
9. Other Accrued Liabilities
Other accrued liabilities were summarized as follows:
Accrued marketing costs
Accrued insurance costs
Accrued taxes (other than income taxes)
Employee benefit plan accruals
All other accrued expenses
Total other accrued liabilities
10
10. Long-Term Debt
Long-term debt was summarized as follows:
Lines of Credit
Debentures
Senior Notes
Other Notes Payable
Less: Portion of long-term debt payable within one year
In June 2005, the Company issued $164.8 million of new 5.00% senior notes due 2016 in exchange for $122.2 million of its outstanding 6.375% debentures due 2009 and $42.6 million of its outstanding 7.20% debentures due 2009. The exchange was conducted as a private placement to holders of the existing debentures that were “qualified institutional buyers” within the meaning of Rule 144A of the Securities Act of 1933. As part of the exchange, the Company paid a premium of $15.6 million to holders participating in the exchange. The transaction was accounted for as an exchange of debt, and the $15.6 million premium will be amortized over the life of the new notes. The Company incurred financing transaction costs of $1.3 million related to the exchange of debt which were included in interest expense during the second quarter of 2005. In August 2005, the Company successfully completed a registered exchange offer in which all of the previously issued private notes were exchanged for substantially identical registered notes.
11
On April 7, 2005, the Company entered into a new five-year $100 million revolving credit facility replacing the existing $125 million facility that was scheduled to expire in December 2005. On October 2, 2005, there were no amounts outstanding under this facility. The $100 million facility matures in April 2010. The new facility includes an option to extend the term for an additional year at the discretion of the participating banks. The new revolving credit facility bears interest at a floating base rate or a floating rate of LIBOR plus an interest rate spread of .375%. In addition, there is a facility fee of .125% required for this revolving credit facility. Both the interest rate spread and the facility fee are determined from a commonly used pricing grid based on the Company’s long-term senior unsecured noncredit-enhanced debt rating. The Company’s new revolving credit facility contains two financial covenants related to ratio requirements for interest coverage, and long-term debt to cash flow, each as defined in the credit agreement. These covenants do not currently, and the Company does not anticipate that they will, restrict its liquidity or capital resources.
The Company borrows periodically under its available lines of credit. These lines of credit, in the aggregate amount of $60 million at October 2, 2005, are made available at the discretion of two participating banks and may be withdrawn at any time by such banks. The Company intends to renew the lines of credit as they mature. To the extent that borrowings under the lines of credit and borrowings under the revolving credit facility do not exceed the amount available under the Company’s revolving credit facility and the term of the revolving credit facility matures in more than 12 months, such borrowings are classified as noncurrent liabilities. On October 2, 2005, there were no amounts outstanding under the lines of credit. On January 2, 2005 and September 26, 2004, $8.0 million and $3.0 million, respectively, were outstanding under the lines of credit.
After taking into account all of the interest rate hedging activities, the Company had a weighted average interest rate of 5.9%, 5.6% and 5.3% for its debt and capital lease obligations as of October 2, 2005, January 2, 2005 and September 26, 2004, respectively. The Company’s overall weighted average interest rate on its debt and capital lease obligations, excluding the financing transaction costs related to the debt exchange, would have been 6.0% for first nine months of 2005 compared to 5.1% for the first nine months of 2004. Including the $1.3 million of financing transaction costs related to the Company’s debt exchange, the overall weighted average interest rate for the first nine months of 2005 was 6.2%. As of October 2, 2005, approximately 42% of the Company’s debt and capital lease obligations of $779.7 million was subject to changes in short-term interest rates. The Company considers all floating rate debt and fixed rate debt with a maturity of less than one year to be subject to changes in short-term interest rates.
If average interest rates for the floating rate component of the Company’s debt and capital lease obligations increased by 1%, interest expense for the first nine months of 2005 would have increased by approximately $2.5 million and net income would have been reduced by approximately $1.4 million.
All of the outstanding long-term debt has been issued by the Company with none being issued by any of the Company’s subsidiaries. There are no guarantees of the Company’s debt.
12
11. Derivative Financial Instruments
The Company periodically uses interest rate hedging products to mitigate risk from interest rate fluctuations. The Company has historically altered its fixed/floating rate mix based upon anticipated cash flows from operations relative to the Company’s debt level and the potential impact of changes in interest rates on the Company’s overall financial condition. Sensitivity analyses are performed to review the impact on the Company’s financial position and coverage of various interest rate movements. The Company does not use derivative financial instruments for trading purposes nor does it use leveraged financial instruments. All of the Company’s outstanding interest rate swap agreements are LIBOR-based.
Derivative financial instruments were summarized as follows:
Interest rate swap agreement-floating
The Company had six interest rate swap agreements as of October 2, 2005 with varying terms that effectively converted $250 million of the Company’s fixed rate debt to a floating rate. All of the interest rate swap agreements have been accounted for as fair value hedges.
The counterparties to these contractual arrangements are major financial institutions with which the Company also has other financial relationships. The Company uses several different financial institutions for interest rate derivative contracts to minimize the concentration of credit risk. While the Company is exposed to credit loss in the event of nonperformance by these counterparties, the Company does not anticipate nonperformance by these parties. The Company has master agreements with the counterparties to its derivative financial agreements that provide for net settlement of the derivative transactions.
12. Fair Values of Financial Instruments
The following methods and assumptions were used by the Company in estimating the fair values of its financial instruments:
Cash, Accounts Receivable and Accounts Payable
The fair values of cash, accounts receivable and accounts payable approximate carrying values due to the short maturity of these financial instruments.
13
Public Debt Securities
The fair values of the Company’s public debt securities are based on estimated market prices.
Non-Public Variable Rate Long-Term Debt
The carrying amounts of the Company’s variable rate borrowings approximate their fair values.
Non-Public Fixed Rate Long-Term Debt
The fair values of the Company’s other notes payable are estimated using discounted cash flow analyses based on the Company’s current borrowing rates for similar types of borrowing arrangements.
Derivative Financial Instruments
Fair values for the Company’s interest rate swap agreements are based on current settlement values.
Letters of Credit
The fair values of the Company’s letters of credit are based on the notional amounts of the instruments. These letters of credit primarily relate to the Company’s property and casualty insurance programs.
The carrying amounts and fair values of the Company’s long-term debt, derivative financial instruments and letters of credit were as follows:
Public debt securities
Non-public variable rate long-term debt
Non-public fixed rate long-term debt
Interest rate swap agreements
Letters of credit
The fair values of the interest rate swap agreements at October 2, 2005 and January 2, 2005 represent the estimated amounts the Company would have paid upon termination of these agreements. The fair value of the interest rate swap agreements on September 26, 2004 represents the estimated amounts the Company would have received upon termination of these agreements.
14
13. Other Liabilities
Other liabilities were summarized as follows:
Accruals for executive benefit plans
Total other liabilities
Accruals for executive benefit plans as of October 2, 2005 reflected the reduction of an accrual for deferred compensation of $1.1 million due to the resignation of an executive during the second quarter of 2005.
14. Commitments and Contingencies
The Company is a member of three cooperatives in which it has ongoing business relationships and has guaranteed a portion of the debt for two of these cooperatives. The amounts guaranteed were $42.5 million, $41.4 million and $44.7 million as of October 2, 2005, January 2, 2005 and September 26, 2004, respectively. The Company has not recorded any liability associated with these guarantees. The Company holds no assets as collateral against these guarantees and no contractual recourse provision exists that would enable the Company to recover amounts guaranteed. The guarantees relate to debt and lease obligations, which resulted primarily from the purchase of production equipment and facilities. These guarantees expire at various times through 2021. The members of both cooperatives consist solely of Coca-Cola bottlers. The Company does not anticipate that either of these cooperatives will fail to fulfill their commitments under these agreements. The Company further believes that each of these cooperatives has sufficient assets, including production equipment, facilities and working capital, and the ability to adjust selling prices of their products to adequately mitigate the risk of material loss.
The Company has identified the two cooperatives for which it has guaranteed debt as variable interest entities and has determined that it is not the primary beneficiary of either of the cooperatives. The Company’s variable interest in these cooperatives includes an equity ownership in each of the entities and the guarantee of certain indebtedness. As of October 2, 2005, these entities had total assets of approximately $399.9 million, total debt of approximately $282.9 million and total revenues for the first nine months of 2005 of approximately $533.1 million. In the event either of these cooperatives fail to fulfill their commitments under the related debt and lease obligations, the Company would be responsible for payments to the lenders up to the level of the guarantees. If these cooperatives had borrowed up to their borrowing capacity, the Company’s potential amount of payments under these guarantees on October 2, 2005 would have been $57.4 million and the Company’s maximum total exposure, including its equity investment, would have been $64.3 million. The Company has been purchasing plastic bottles and finished can products from these cooperatives for more than ten years.
The Company is involved in various claims and legal proceedings which have arisen in the ordinary course of business. Although it is difficult to predict the ultimate outcome of these claims and legal proceedings, management believes that the ultimate disposition of these matters will not have a material adverse effect on the
15
financial condition, cash flows or results of operations of the Company. No material amount of loss in excess of recorded amounts is believed to be reasonably possible.
The Company’s tax filings are subject to audit by tax authorities in jurisdictions where it conducts business. These audits may result in assessments of additional taxes that are subsequently resolved with the authorities or potentially through the courts. Management believes the Company has adequately provided for any ultimate amounts that are likely to result from these audits; however, final assessments, if any, could be different than the amounts provided in the financial statements.
15. Income Taxes
The provision for income taxes consisted of the following:
Current:
Federal
State
Total current provision
Deferred:
Total deferred provision
Income tax expense
Reported income tax expense is reconciled to the amount computed on the basis of income before income taxes at the statutory rate as follows:
Statutory expense
State income taxes, net of federal benefit
Impact of state tax audit and updated assessment of state income tax liability
Meals and entertainment
During the second quarter of 2005, the Company entered into a settlement agreement with a state whereby the Company agreed to reduce certain net operating loss carryforwards and to pay certain additional taxes and interest relating to prior years. The loss of state net operating loss carryforwards, net of federal tax benefit, of $4.4 million did not have an effect on the provision for income taxes due to a valuation allowance
16
previously recorded for such deferred tax assets. Under this settlement, the Company was required to pay $5.7 million in the second quarter of 2005 and is required to pay an additional $5.0 million by April 15, 2006. The amounts paid and the liability remaining in excess of reserves previously recorded had the effect of increasing income tax expense by approximately $4.1 million in the second quarter of 2005. Based on an analysis of current facts, the Company also made adjustments to reserves for income tax exposure in other states in the second quarter which had the effect of decreasing income tax expense by $3.8 million. The Company’s income tax reserves are subject to adjustment in future periods based on the Company’s ongoing evaluations of its income tax liabilities and new information that becomes available to the Company.
The Company’s effective income tax rates for the first nine months of 2005 and the first nine months of 2004 were 41.5% and 42.1%, respectively.
16. Accumulated Other Comprehensive Income (Loss)
The reconciliation of the components of accumulated other comprehensive income (loss) was as follows:
Balance as of December 28, 2003
Change in fair market value of cash flow hedges, net of tax
Balance as of September 26, 2004
Balance as of January 2, 2005 and October 2, 2005
A summary of the components of accumulated other comprehensive income (loss) was as follows:
First nine months 2004
Net gain (loss) on derivatives
Other comprehensive income (loss)
First nine months 2005
17
17. Capital Transactions
On May 12, 1999, the stockholders of the Company approved a restricted stock award for J. Frank Harrison, III, the Company’s Chairman of the Board of Directors and Chief Executive Officer, consisting of 200,000 shares of the Company’s Class B Common Stock. The fair value of the restricted stock award, when approved, was approximately $11.7 million based on the market price of the Common Stock on the effective date of the award. The award provides that the shares of restricted stock vest at the rate of 20,000 shares per year over a ten-year period. The vesting of each annual installment is contingent upon the Company achieving at least 80% of the overall goal achievement factor in the Company’s Annual Bonus Plan. As of October 2, 2005, the fair market value of the potentially issuable shares (80,000 shares over the next four years) under this award approximated $3.9 million. Compensation expense related to the restricted stock award was $1.3 million and $1.4 million for the first nine months of 2005 and for the first nine months of 2004, respectively.
On March 3, 2004, the Compensation Committee of the Board of Directors determined that 20,000 shares of restricted Class B Common Stock vested and should be issued pursuant to the performance-based award discussed above to J. Frank Harrison, III, in connection with his services as Chairman of the Board of Directors and Chief Executive Officer of the Company. On February 23, 2005, the Compensation Committee determined that an additional 20,000 shares of restricted Class B Common Stock vested.
The increase in the number of shares outstanding in the first quarter of 2005 and the first quarter of 2004 was due to the issuance in each quarter of 20,000 shares of Class B Common Stock related to the restricted stock award. During the third quarter of 2005, 500 shares of Class B Common Stock were converted to 500 shares of Common Stock.
18. Benefit Plans
Retirement benefits under the two Company-sponsored pension plans are based on the employee’s length of service, average compensation over the five consecutive years which gives the highest average compensation and the average of the Social Security taxable wage base during the 35-year period before a participant reaches Social Security retirement age. Contributions to the plans are based on the projected unit credit actuarial funding method and are limited to the amounts that are currently deductible for income tax purposes.
18
Net periodic pension cost for the indicated periods was as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Net periodic pension cost
The Company contributed $8.0 million to its pension plans during the first nine months of 2005.
The Company provides postretirement benefits for a portion of its current employees. The Company recognizes the cost of postretirement benefits, which consist principally of medical benefits, during employees’ periods of active service. Qualifying active employees are eligible for coverage upon retirement until they become eligible for Medicare (normally age 65), at which time coverage under the plan will cease. The Company does not pre-fund these benefits.
The components of net periodic postretirement benefit cost were as follows:
Amortization of unrecognized transitional assets
Net periodic postretirement benefit cost
19. Related Party Transactions
The Company’s business consists primarily of the production, marketing and distribution of nonalcoholic beverages of The Coca-Cola Company, which is the sole owner of the secret formulas under which the primary components (either concentrate or syrup) of its soft drink products are manufactured. As of October 2, 2005, The Coca-Cola Company had a 27.3% interest in the Company’s total outstanding Common Stock and Class B Common Stock on a combined basis.
19
The following table summarizes the significant transactions between the Company and The Coca-Cola Company:
In Millions
Payments by the Company for concentrate, syrup, sweetener and other purchases
Marketing funding support payments to the Company
Payments net of marketing funding support
Payments by the Company for customer marketing programs
Payments by the Company for cold drink equipment parts
Fountain delivery and equipment repair fees paid to the Company
Presence marketing funding support provided by The Coca-Cola Companyon the Company’s behalf
Sale of energy products to The Coca-Cola Company
The Company received proceeds in the second quarter of 2005 as a result of a settlement of a class action lawsuit known as In re: High Fructose Corn Syrup Antitrust Litigation Master File No. 95-1477 in the United States District Court for the Central District of Illinois. The lawsuit related to purchases of high fructose corn syrup by several companies, including The Coca-Cola Company and its subsidiaries, The Coca-Cola Bottlers’ Association and various Coca-Cola bottlers, during the period from July 1, 1991 to June 30, 1995. The Company recognized the proceeds received of $6.4 million as a reduction of cost of sales during the second quarter. The proceeds received represent approximately 90% of the expected recovery with the estimated remaining balance to be received in late 2005 or early 2006. Any additional recovery, however, is subject to Court approval. Accordingly, the Company has not recognized any amounts for possible collection of these remaining reimbursements since the ultimate outcome is not determinable.
Marketing funding support in the first quarter of 2004 included a favorable nonrecurring item of approximately $2 million for certain customer-related marketing programs between the Company and The Coca-Cola Company.
The Company has a production arrangement with Coca-Cola Enterprises Inc. (“CCE”) to buy and sell finished products at cost. Sales to CCE under this agreement were $32.8 million and $18.9 million in the first nine months of 2005 and the first nine months of 2004, respectively. Purchases from CCE under this arrangement were $13.7 million and $14.5 million in the first nine months of 2005 and the first nine months of 2004, respectively. The Coca-Cola Company has significant equity interests in the Company and CCE. As of October 2, 2005, CCE held 10.5% of the Company’s outstanding Common Stock but held no shares of the Company’s Class B Common Stock, giving CCE a 7.7% equity interest in the Company’s total outstanding Common Stock and Class B Common Stock on a combined basis.
20
Along with all the other Coca-Cola bottlers in the United States, the Company has become a member in Coca-Cola Bottlers’ Sales and Services Company, LLC (“CCBSS”), which was formed in 2003 for the purposes of facilitating various procurement functions and distributing certain specified beverage products of The Coca-Cola Company with the intention of enhancing the efficiency and competitiveness of the Coca-Cola bottling system in the United States. CCBSS negotiated the procurement for the majority of the Company’s raw materials (excluding concentrate) in 2004 and the first nine months of 2005. The Company paid approximately $250,000 to CCBSS for its share of the administrative costs of CCBSS for both the first nine months of 2005 and the first nine months of 2004. CCE is also a member of CCBSS.
The Company provides a portion of the finished products for Piedmont at cost and receives a fee for managing the operations of Piedmont pursuant to a management agreement. The Company sold product at cost to Piedmont during the first nine months of 2005 and the first nine months of 2004 totaling $51.3 million and $57.9 million, respectively. The Company received $16.0 million and $13.3 million for management services pursuant to its management agreement with Piedmont for the first nine months of 2005 and the first nine months of 2004, respectively. The Company provides financing for Piedmont at the Company’s average cost of funds plus 0.50%. As of October 2, 2005, the Company had loaned $109.2 million to Piedmont. The loan was amended on August 25, 2005 to extend the maturity date from December 31, 2005 to December 31, 2010 on terms comparable to the previous loan. The Company also subleases various fleet and vending equipment to Piedmont at cost. These sublease rentals amounted to $6.5 million and $6.2 million in the first nine months of 2005 and the first nine months of 2004, respectively. In addition, Piedmont subleases various fleet and vending equipment to the Company at cost. These sublease rentals amounted to approximately $120,000 and $130,000 during the first nine months of 2005 and the first nine months of 2004, respectively. All significant intercompany accounts and transactions between the Company and Piedmont have been eliminated.
The Company is a shareholder in two cooperatives from which it purchases substantially all its requirements for plastic bottles. Net purchases from these entities were $52.4 million and $44.7 million in the first nine months of 2005 and the first nine months of 2004, respectively. In connection with its participation in one of these cooperatives, the Company has guaranteed a portion of the cooperative’s debt. Such guarantee amounted to $22.5 million as of October 2, 2005.
The Company is also a member of South Atlantic Canners, Inc. (“SAC”), a manufacturing cooperative. SAC sells finished products to the Company and Piedmont at cost. Purchases from SAC by the Company and Piedmont for finished products were $94.7 million and $81.0 million in the first nine months of 2005 and the first nine months of 2004, respectively. The Company also manages the operations of SAC pursuant to a management agreement. Management fees earned from SAC were $1.1 million and $1.3 million in the first nine months of 2005 and the first nine months of 2004, respectively. The Company has also guaranteed the debt and lease obligations for SAC. Such guarantee was $20.0 million as of October 2, 2005.
21
The Company leases from Harrison Limited Partnership One (“HLP”) the Snyder Production Center and an adjacent sales facility, which are located in Charlotte, North Carolina. HLP’s sole limited partner is a trust of which J. Frank Harrison, III, Chairman of the Board of Directors and Chief Executive Officer of the Company, is a trustee. The principal balance outstanding under this capital lease as of October 2, 2005 was $39.8 million. Rental payments related to this lease were $2.5 million and $2.0 million in the first nine months of 2005 and the first nine months of 2004, respectively.
On June 1, 1993, the Company entered into a lease agreement with Beacon Investment Corporation (“Beacon”) related to the Company’s headquarters office facility. Beacon’s sole shareholder is J. Frank Harrison, III. On January 5, 1999, the Company entered into a ten-year agreement with Beacon which included the Company’s headquarters office facility and an adjacent office facility. On March 1, 2004, the Company recorded a capital lease of $32.4 million related to these facilities when the Company received a renewal option to extend the term of the lease, which it expects to exercise. The principal balance outstanding under this capital lease as of October 2, 2005 was $31.5 million. Rental payments related to this lease were $2.4 million and $2.1 million in the first nine months of 2005 and the first nine months of 2004, respectively.
In March 2005, the Company entered into a two-year consulting agreement with Robert D. Pettus, Jr. Mr. Pettus served as an officer of the Company in various capacities from 1984 and is currently the Vice Chairman of the Board of Directors of the Company. Mr. Pettus will receive $350,000 per year plus additional benefits as described in the consulting agreement during the term of this consulting agreement.
In June 2005, the Company entered into a two-year consulting agreement with David V. Singer. Mr. Singer served the Company as Executive Vice President and Chief Financial Officer until his resignation on May 11, 2005. The Company agreed to waive the 50% reduction in Mr. Singer’s accrued benefits under the Company’s Officer Retention Plan due to the termination of his employment before age 55. Under the consulting agreement, Mr. Singer agreed to certain non-compete restrictions for a five-year period following his resignation. The net adjustment to the Company’s executive benefit accruals as a result of Mr. Singer’s resignation was a $1.1 million reduction in S,D&A expenses in the second quarter of 2005.
22
20. Earnings Per Share
The following table sets forth the computation of basic net income per share and diluted net income per share:
Numerator:
Numerator for basic net income per share and diluted net income per share
Denominator:
Denominator for basic net income per share and diluted net income per share – weighted average common shares
No potentially dilutive shares were outstanding in the periods presented.
21. Risks and Uncertainties
The Company’s products are sold and distributed directly by its employees to retail stores and other outlets. During the first nine months of 2005, approximately 66% of the Company’s bottle/can volume to retail customers was sold for future consumption. The remaining bottle/can volume to retail customers of approximately 34% was sold for immediate consumption. The Company’s largest customers, Wal-Mart Stores, Inc. and Food Lion, LLC, accounted for approximately 14% and 10%, respectively, of the Company’s total bottle/can volume to retail customers during the first nine months of 2005. Wal-Mart Stores, Inc. accounted for approximately 11% of the Company’s total net sales during the first nine months of 2005.
The Company makes significant expenditures each year for aluminum cans and plastic bottles, on fuel for product delivery and for health care costs. Material increases in the costs of aluminum cans, plastic bottles or fuel or in health care costs may result in a reduction in earnings to the extent the Company is not able to increase its selling prices to offset increases in the costs of aluminum cans, plastic bottles or fuel or in health care costs.
Certain liabilities of the Company are subject to risk of changes in both long-term and short-term interest rates. These liabilities include floating rate debt, leases with payments determined on floating interest rates, postretirement benefit obligations and the Company’s pension liability.
23
Less than 7% of the Company’s labor force is currently covered by collective bargaining agreements. There are no collective bargaining agreements that will expire during the remainder of 2005.
22. Supplemental Disclosures of Cash Flow Information
Changes in current assets and current liabilities affecting cash were as follows:
Accounts receivable, trade, net
23. New Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 151, “Inventory Costs – an amendment of ARB No. 43, Chapter 4.” This Statement clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) and is effective for fiscal years beginning after June 15, 2005. The Company anticipates that the adoption of this Statement will not have a material impact on its consolidated financial statements.
In December 2004, the FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets – an amendment of APB Opinion No. 29.” This Statement eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges on nonmonetary assets that do not have commercial substance and is effective for fiscal periods beginning after June 15, 2005. The adoption of this Statement did not have a material impact on the Company’s consolidated financial statements.
24
In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment.” This Statement is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and is effective for the Company as of the beginning of the first quarter of fiscal year 2006. This Statement requires public companies to measure the cost of employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award. The Company will adopt this Statement beginning January 2, 2006, and will adopt using one of the two transition methods. The Company anticipates that the adoption of this Statement will not have a material impact on its consolidated financial statements.
In October 2004, the American Jobs Creation Act of 2004 (the “Jobs Act”) was signed into law. The Jobs Act provided for a tax deduction for qualified production activities. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (“FAS 109-1”), which was effective immediately. FAS 109-1 provides guidance on the accounting for the provision within the Jobs Act that provides a tax deduction on qualified production activities. The Company estimates that the deduction for qualified production activities provided within the Jobs Act and the Company’s related adoption of FAS 109-1 will reduce the Company’s effective income tax rate by approximately 1% in 2005.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 clarifies that a conditional asset retirement obligation, as used in FASB Statement 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of the settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. FIN 47 is effective as of the end of fiscal years ending after December 15, 2005. The Company anticipates that the adoption of this Interpretation will not have a material impact on its consolidated financial statements.
In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3.” This Statement requires retrospective application to prior period financial statements of a voluntary change in accounting principle unless it is impracticable and is effective for fiscal years beginning after December 15, 2005. Previously, most voluntary changes in accounting principle were recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle.
25
Introduction
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“M,D&A”) should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes to consolidated financial statements. M,D&A includes the following sections:
The consolidated statements of operations for the three months and the nine months ended October 2, 2005 and September 26, 2004, the consolidated statements of cash flows for the nine months ended October 2, 2005 and September 26, 2004 and the consolidated balance sheets at October 2, 2005, January 2, 2005 and September 26, 2004 include the consolidated operations of the Company and its majority owned subsidiaries including Piedmont Coca-Cola Bottling Partnership (“Piedmont”). Minority interest consists of The Coca-Cola Company’s interest in Piedmont, which was 22.7% for all periods presented.
Our Business
Coca-Cola Bottling Co. Consolidated (the “Company”) produces, markets and distributes nonalcoholic beverages, primarily products of The Coca-Cola Company, which include some of the most recognized and popular beverage brands in the world. The Company is the second largest bottler of products of The Coca-Cola Company in the United States, operating in eleven states, primarily in the Southeast. The Company also distributes several other beverage brands. The Company’s product offerings include carbonated soft drinks,
26
bottled water, teas, juices, isotonics and energy drinks. The Company had net sales of approximately $1.3 billion in 2004.
The carbonated soft drink market and the noncarbonated beverage market are highly competitive. The Company’s competitors in these markets include bottlers and distributors of nationally advertised and marketed products, regionally advertised and marketed products and private label soft drinks. In each region in which the Company operates, between 75% and 90% of carbonated soft drink sales in bottles, cans and other containers are accounted for by the Company and its principal competitors, which in each region includes the local bottler of Pepsi-Cola and, in some regions, the local bottler of Royal Crown and/or 7-Up products. During the last two years, volume of total carbonated soft drinks in the soft drink industry has been soft. The decline in sugar carbonated beverages is partially offset by volume growth from diet carbonated beverages, isotonics, bottled water and energy products. Volume in the soft drink industry has also been negatively impacted by less aggressive price promotion by some retailers in the future consumption channels.
The principal methods of competition in the soft drink industry are point-of-sale merchandising, new product introductions, new vending and dispensing equipment, packaging changes, pricing, price promotions, product quality, retail space management, customer service, frequency of distribution and advertising. The Company believes that it is competitive in its territories with respect to each of these methods of competition.
Operating results for the third quarter and first nine months of 2005 are not indicative of results that may be expected for the fiscal year ending January 1, 2006 because of business seasonality. Historically, business seasonality results primarily from higher unit sales of the Company’s products in the second and third quarters versus the first and fourth quarters of the fiscal year. Fixed costs, such as depreciation, amortization and interest expense, are not significantly impacted by business seasonality.
The Company’s bottle/can volume by product category as a percentage of total bottle/can volume was as follows:
Product Category
Sugar carbonated soft drinks
Diet carbonated soft drinks
Total carbonated soft drinks
Bottled water
Isotonics
Other noncarbonated beverages
Total noncarbonated beverages
Total bottle/can volume
Areas of Emphasis
Key priorities for the Company during 2005 and over the next several years include revenue management, product innovation, distribution cost management and productivity.
27
Revenue Management
Revenue management includes striking the appropriate balance between generating growth in volume, gross margin and market share. It requires a strategy which reflects consideration for pricing of brands and packages within channels, as well as highly effective working relationships with customers and disciplined fact-based decision-making. Revenue management has been and continues to be a key performance driver which has significant impact on the Company’s operating income.
Product Innovation
Volume growth of sugar carbonated soft drinks has slowed over the past several years and innovation of both brands and packages has been and will continue to be critical to the Company’s overall volume. During the first quarter of 2005, the Company introduced Coca-Cola with Lime and Full Throttle, an energy product from The Coca-Cola Company. During June 2005, the Company introduced Coca-Cola Zero, Dasani flavors, and Vault in certain markets. The Company will introduce Vault in the Company’s remaining markets in the fourth quarter of 2005. The Company introduced diet Coke with Lime, Coca-Cola C2 and Rockstar in 2004. In addition, the Company has also developed specialty packaging for customers in certain channels over the past several years.
Distribution Cost Management
Distribution cost, which represents the cost of transporting finished goods from Company locations to customer outlets, is the second largest expense category for the Company. Total distribution costs amounted to $136.3 million and $130.7 million in the first nine months of 2005 and the first nine months of 2004, respectively. Over the past several years, the Company has focused on converting its distribution system from a conventional routing system to a predictive or pre-sell system. This conversion to a pre-sell system has allowed the Company to more efficiently handle an increasing number of brands and packages. In addition, the Company has closed a number of smaller sales distribution centers reducing its fixed warehouse-related costs. Distribution cost management will continue to be a key area of emphasis for the Company for the next several years.
Productivity
To achieve improvements in operating performance over the long-term, the Company’s gross margin must grow faster than the increase in selling, delivery and administrative (“S,D&A”) expenses. A key driver in the Company’s S,D&A expense management relates to ongoing improvements in labor productivity and asset productivity. The Company continues to focus on its supply chain and distribution functions for opportunities to improve productivity.
28
Overview of Operations and Financial Condition
The following overview provides a summary of key information concerning the Company’s financial results for the third quarter and first nine months of 2005 compared to the third quarter and first nine months of 2004.
%
Change
Income before taxes
Basic net income per share (6)
Gross margin (1)(2)(5)
Income from operations (1)(2)(3)(5)
Interest expense (4)
Income before taxes (1)(2)(3)(4)(5)
Net income (1)(2)(3)(4)(5)
Basic net income per share (1)(2)(3)(4)(5)(6)
The Company’s net sales grew approximately 12% and approximately 9% during the third quarter and first nine months of 2005 compared to the corresponding periods of 2004. The net sales increase in the third quarter was primarily due to an increase in average revenue per case of approximately 3%, an increase in bottle/can volume of approximately 4% and an increase in contract sales to other bottlers of $15.6 million. Average revenue per case increased by approximately 2%, bottle/can volume increased by approximately 3% and contract sales to other
29
bottlers increased by $41.6 million for the first nine months of 2005 compared to the first nine months of 2004. The Company anticipates that growth in overall bottle/can volume will be primarily dependent upon continued growth in diet products, isotonics, bottled water and energy drinks as well as the introduction of new products.
Gross margin improved in the first nine months of 2005 compared to the first nine months of 2004 due, in part, to the receipt of $6.4 million from the settlement of a class action lawsuit known as In re: High Fructose Corn Syrup Antitrust Litigation Master File No. 95-1477 in the United States District Court for the Central District of Illinois. The lawsuit related to purchases of high fructose corn syrup by several companies, including The Coca-Cola Company and its subsidiaries, The Coca-Cola Bottlers’ Association and various Coca-Cola bottlers, during the period from July 1, 1991 to June 30, 1995. The Company recognized the proceeds received as a reduction of cost of sales during the second quarter of 2005. The proceeds received represent approximately 90% of the expected recovery with the estimated remaining balance to be received in late 2005 or early 2006. Any additional recovery, however, is subject to Court approval. Accordingly, the Company has not recognized any amounts for possible collection of these remaining reimbursements since the ultimate outcome is not determinable. Despite the proceeds received from the high fructose corn syrup litigation, the Company’s gross margin as a percentage of net sales declined in the first nine months of 2005 compared to the same period in 2004 due to higher cost of sales related primarily to increased packaging material costs and the impact of higher contract sales which have lower margins.
Interest expense increased $1.2 million and $4.6 million during the third quarter and first nine months of 2005 compared to the third quarter and first nine months of 2004, respectively. The increase is attributable to financing transaction costs of $1.3 million in the second quarter of 2005 related to the exchange of $164.8 million of the Company’s long-term debentures and higher interest rates on the Company’s floating rate debt, partially offset by the impact of lower debt balances and short-term cash investments.
Debt and capital lease obligations were summarized as follows:
Debt
Capital lease obligations
Total debt and capital lease obligations
Discussion of Critical Accounting Policies and New Accounting Pronouncements
Critical Accounting Policies
In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company included in its Annual Report on Form 10-K for the year ended January 2, 2005 a discussion of the Company’s most critical accounting policies, which are those that are most important to the portrayal of the Company’s financial condition and results of operations and require management’s most difficult, subjective
30
and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
The Company has not made changes in any critical accounting policies during the third quarter of 2005. Any changes in critical accounting policies are discussed with the Audit Committee of the Board of Directors of the Company during the quarter in which a change is made.
New Accounting Pronouncements
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 clarifies that a conditional asset retirement obligation, as used in FASB Statement 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an
31
asset retirement activity in which the timing and/or method of the settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. FIN 47 is effective as of the end of fiscal years ending after December 15, 2005. The Company anticipates that the adoption of this Interpretation will not have a material impact on its consolidated financial statements.
Results of Operations
Third Quarter 2005 Compared to Third Quarter 2004 and First Nine Months 2005 Compared to First Nine Months 2004
Net Income
The Company reported net income of $8.8 million or $.97 per basic share for the third quarter of 2005 compared with net income of $6.1 million or $.67 per basic share for the third quarter of 2004. Net income for the first nine months of 2005 was $21.0 million or $2.32 per basic share compared to $19.5 million or $2.15 per basic share for the first nine months of 2004. Results in all periods presented include infrequent or nonrecurring items on a pre-tax basis as follows:
32
Net Sales
Net sales in the third quarter and first nine months of 2005 increased by approximately 12% and approximately 9%, respectively. The net sales increases were primarily due to increases in average revenue per case of approximately 3% and approximately 2% for the third quarter and first nine months of 2005, respectively, increases in bottle/can volume of approximately 4% and approximately 3% for the third quarter and first nine months of 2005, respectively, and increased contract sales to other Coca-Cola bottlers.
The Company’s contract net sales increased to $33.7 million in the third quarter of 2005 compared to $18.1 million for the comparable period in 2004, an increase of $15.6 million or approximately 86%. Contract sales for the first nine months of 2005 were approximately $95.7 million compared to $54.1 million in the first nine months of 2004, an increase of $41.6 million or approximately 77%. The significant increase in contract sales resulted from volume related to new customers and shipments of Full Throttle, the new energy product of The Coca-Cola Company. The Company produces this product for Coca-Cola bottlers in the eastern half of the United States.
The percentage increases (decreases) in bottle/can volume by product category in the third quarter and first nine months of 2005 compared to the third quarter and first nine months of 2004 were as follows:
Other noncarbonated beverages (including energy drinks)
The Company’s noncarbonated beverage portfolio continues to provide strong volume growth with Dasani growing at 22% and PowerAde growing at 30% and with the newly introduced energy drinks Full Throttle and Rockstar accounting for .5% of total volume in the first nine months of 2005. The Company has encountered significant pricing pressure in the supermarket channel for bottled water with average revenue per case declining by approximately 13% from the first nine months of 2005 compared to the first nine months of 2004.
The Company has introduced several new products during 2005. During the second quarter of 2005, the Company introduced Coca-Cola Zero, Dasani flavors, and Vault in certain markets. During the first quarter of 2005, the Company introduced Coca-Cola with Lime and Full Throttle, an energy product. Product innovation will continue to be an important factor impacting the Company’s overall bottle/can volume in the future.
The Company’s products are sold and distributed through various channels. These channels include selling directly to retail stores and other outlets such as food markets, institutional accounts and vending machine outlets. During the first nine months of 2005, approximately 66% of the Company’s bottle/can volume was
33
sold for future consumption. The remaining bottle/can volume of approximately 34% was sold for immediate consumption. The Company’s largest customer, Wal-Mart Stores, Inc., accounted for approximately 14% of the Company’s total bottle/can volume during the first nine months of 2005. The Company’s second largest customer, Food Lion, LLC, accounted for approximately 10% of the Company’s total bottle/can volume during the first nine months of 2005. Wal-Mart Stores, Inc. accounted for approximately 11% of the Company’s total net sales during the first nine months of 2005. All of the Company’s sales are to customers in the United States.
Gross Margin
Gross margins for the first nine months of 2005 and the first nine months of 2004 were impacted by adjustments for items that are not necessarily indicative of the Company’s ongoing results. Excluding these adjustments, the Company’s gross margins and gross margins as a percentage of net sales would have been as follows:
Gross margin as reported
Adjustments:
High fructose corn syrup litigation proceeds
Change in concentrate pricing
Customer marketing programs adjustment
Gross margin as adjusted
Percentage of Net Sales
Gross margin percentage as reported
Gross margin percentage as adjusted
The non-GAAP financial measures “Gross margin as adjusted” and “Gross margin percentage as adjusted” are provided to allow investors to more clearly evaluate gross margin trends. These measures exclude the impact of high fructose corn syrup litigation proceeds in 2005, and a change in concentrate pricing and an adjustment of customer marketing programs reimbursements in 2004. The 3.1% decrease in gross margin as a percentage of net sales as adjusted in the first nine months of 2005 resulted primarily from the impact of higher contract sales, which have lower margins (1.8% of the 3.1% decrease). The remainder of the decrease resulted primarily from increases in the Company’s packaging costs.
The Company’s gross margins as a percentage of net sales may not be comparable to other companies, since some entities include all costs related to their distribution network in cost of sales and the Company excludes a portion of these costs from gross margin, including them instead in S,D&A expenses.
34
Cost of Sales
Cost of sales on a per unit basis for bottle/can volume increased approximately 3% in the third quarter and the first nine months of 2005 compared to the comparable periods of 2004. The increase in cost of sales for the first nine months was mitigated by the $6.4 million settlement of litigation regarding purchases of high fructose corn syrup in the second quarter of 2005 which partially offset higher raw material costs. During the second quarter of 2004, The Coca-Cola Company changed its method of concentrate pricing, resulting in a change in the Company’s investment in inventories, resulting in a one-time increase in cost of sales of $1.7 million. Packaging costs per unit increased by approximately 7% during the third quarter of 2005 as compared to the third quarter of 2004. Packaging costs per unit increased more than 10% during the first nine months of 2005 compared to the same period in 2004. The increase in packaging costs in 2005 relates to significantly higher plastic bottle costs and increased aluminum can costs.
The Company relies extensively on advertising and sales promotion in the marketing of its products. The Coca-Cola Company and other beverage companies that supply concentrates, syrups and finished products to the Company make substantial marketing and advertising expenditures to promote sales in the local territories served by the Company. The Company also benefits from national advertising programs conducted by The Coca-Cola Company and other beverage companies. Certain of the marketing expenditures by The Coca-Cola Company and other beverage companies are made pursuant to annual arrangements. Although The Coca-Cola Company has advised the Company that it intends to continue to provide marketing funding support for the remainder of 2005, it is not obligated to do so under the Company’s Bottle Contracts. Significant decreases in marketing funding support from The Coca-Cola Company or other beverage companies could adversely impact operating results of the Company in the future.
Total marketing funding support from The Coca-Cola Company and other beverage companies, which includes direct payments to the Company and payments to customers for marketing programs, was $22.2 million for the first nine months of 2005 versus $33.7 million for the first nine months of 2004 and was recorded as a reduction in cost of sales. Since May 28, 2004, The Coca-Cola Company has provided the majority of the Company’s marketing funding support for bottle/can products as a reduction in the price of concentrate. The change in concentrate price represents a significant portion of the marketing funding support that previously would have been paid to the Company in cash related to the sale of bottle/can products of The Coca-Cola Company. Accordingly, the amounts received in cash from The Coca-Cola Company for marketing funding support decreased significantly in the first nine months of 2005 as compared to the first nine months of 2004. However, this change in marketing funding support, after taking into account the related reduction in concentrate price, did not have a significant impact on overall results of operations in the first nine months of 2005.
Cost of sales includes the following: raw material costs, manufacturing labor, manufacturing overhead, inbound freight charges related to raw materials, receiving costs, inspection costs, manufacturing warehousing costs and freight charges related to the movement of finished goods from manufacturing locations to sales distribution centers.
S,D&A Expenses
S,D&A expenses increased by 5.7% in the third quarter and 3.7% in the first nine months of 2005 compared to the same periods in 2004. The increase in S,D&A expenses was primarily due to wage increases for the Company’s employees, higher employee benefits costs including pension and health care costs and higher fuel
35
costs. The increase in S,D&A expenses in 2005 was mitigated by the reduction of an accrual for executive benefit plans of $1.1 million due to the resignation of an executive of the Company in the second quarter of 2005. The Company continues to incur increased fuel costs. Fuel costs for the third quarter of 2005 related to the movement of finished goods from sales distribution centers to customer locations increased by approximately 40% or $1.2 million compared to the third quarter of 2004. Fuel costs for the first nine months of 2005 increased by approximately 32% or $2.7 million compared to the first nine months of 2004.
Over the last three years, the Company has converted the majority of its distribution system from a conventional sales method to a pre-sell method in which sales personnel either visit or call a customer to determine the customer’s requirements for their order. This pre-sell method has enabled the Company to add a significant number of new product and package combinations and provides the capacity to add additional product offerings in the future. The Company will continue to evaluate its distribution system in an effort to improve the process of distributing products to customers. Shipping and handling costs related to the movement of finished goods from manufacturing locations to sales distribution centers are included in cost of sales. Shipping and handling costs related to the movement of finished goods from sales distribution centers to customer locations are included in S,D&A expenses and totaled $136.3 million and $130.7 million in the first nine months of 2005 and the first nine months of 2004, respectively. Customers do not pay the Company separately for shipping and handling costs.
In October 2005, the Company announced changes to its postretirement health care plan. These changes will be effective beginning in 2006. Due to the changes announced, the Company anticipates that its expense and liability related to its postretirement health care plan will be reduced. Both the expense and liability for postretirement health care benefits are subject to determination by the Company’s actuaries and include numerous variables that will affect the impact of the announced changes. The Company anticipates that the annual expense for the postretirement health care plan will decrease by approximately $2 million in 2006.
The S,D&A expense line item includes the following: sales management labor costs, distribution costs from sales distribution centers to customer locations, sales distribution center warehouse costs, point-of-sale expenses, advertising expenses, vending equipment repair costs and administrative support labor and operating costs such as treasury, legal, information services, accounting, internal audit and executive management costs.
Depreciation Expense
Depreciation expense for the third quarter and first nine months of 2005 declined by $.8 million and $1.9 million compared to the same periods in the prior year. The decline in depreciation expense was primarily due to lower levels of capital spending.
Amortization of Intangibles
Amortization of intangibles expense for the third quarter and first nine months of 2005 declined by $.6 million and $1.6 million compared to the same periods in 2004. The decline in amortization expense was due to the impact of certain customer relationships which are now fully amortized.
36
Interest Expense
Minority Interest
The Company recorded minority interest expense of $1.2 million during the third quarter of 2005 compared to $1.3 million during the third quarter of 2004 related to the portion of Piedmont owned by The Coca-Cola Company. The Company recorded minority interest expense of $3.2 million during the first nine months of 2005 compared to $3.4 million during the first nine months of 2004 related to the portion of Piedmont owned by The Coca-Cola Company.
Income Taxes
The Company’s effective income tax rate for the first nine months of 2005 was 41.5% compared to 42.1% for the first nine months of 2004. The Company estimates that the adoption of FAS 109-1 will reduce the Company’s effective income tax rate by approximately 1% in 2005.
During the second quarter of 2005, the Company entered into a settlement agreement with a state whereby the Company agreed to reduce certain net operating loss carryforwards and to pay certain additional taxes and interest relating to prior years. The loss of state net operating loss carryforwards, net of federal tax benefit, of $4.4 million did not have an effect on the provision for income taxes due to a valuation allowance previously recorded for such deferred tax assets. Under this settlement, the Company was required to pay $5.7 million in the second quarter of 2005 and is required to pay an additional $5.0 million by April 15, 2006. The amounts paid and the liability remaining in excess of reserves previously recorded had the effect of increasing income tax expense by approximately $4.1 million in the second quarter of 2005. Based on analysis of current facts, the Company also made adjustments to reserves for income tax exposure in other states in the second quarter which had the effect of decreasing income tax expense by $3.8 million. The Company’s income tax reserves are subject to adjustment in future periods based on the Company’s ongoing evaluations of its income tax liabilities and new information that becomes available to the Company.
The Company’s effective tax rate for the first nine months of 2005 reflects expected full year 2005 earnings. The Company’s effective income tax rate for the remainder of 2005 is dependent upon operating results and may change if the results for the year are different from current expectations.
Financial Condition
Total assets increased slightly from $1.31 billion at January 2, 2005 to $1.36 billion at October 2, 2005 primarily due to increases in cash, accounts receivable, inventories and other assets partially offset by a decrease in property, plant and equipment, net. Other assets increased by $14.3 million from January 2, 2005 to
37
October 2, 2005 primarily as a result of the premium paid in conjunction with the debt exchange. Property, plant and equipment, net decreased primarily due to lower levels of capital spending.
Net working capital, defined as current assets less current liabilities, increased by $37.2 million from January 2, 2005 to October 2, 2005 and increased by $51.8 million from September 26, 2004 to October 2, 2005.
Significant changes in net working capital from January 2, 2005 to October 2, 2005 were as follows:
Significant changes in net working capital from September 26, 2004 to October 2, 2005 were as follows:
Debt and capital lease obligations were $779.7 million as of October 2, 2005 compared to $789.1 million as of January 2, 2005 and $784.5 million as of September 26, 2004. Debt and capital lease obligations as of October 2, 2005 included $79.7 million of capital lease obligations related primarily to Company facilities.
Liquidity and Capital Resources
Capital Resources
Sources of capital for the Company include cash flows from operating activities, bank borrowings and the issuance of debt and equity securities. Management believes that the Company, through these sources, has sufficient financial resources available to maintain its current operations and provide for its current capital expenditure and working capital requirements, scheduled debt payments, interest and income tax payments and dividends for stockholders. The amount and frequency of future dividends will be determined by the Company’s Board of Directors in light of the earnings and financial condition of the Company at such time, and no assurance can be given that dividends will be declared in the future.
The Company primarily uses cash flows from operations and available credit facilities to meet its cash requirements. On April 7, 2005, the Company entered into a new $100 million revolving credit facility replacing its existing $125 million revolving credit facility. The $100 million facility matures in April 2010.
38
The Company anticipates that cash provided by operating activities and its credit facilities will be sufficient to meet all of its anticipated cash requirements, including debt and capital lease maturities, through 2008.
In June 2005, the Company issued $164.8 million of new 5.00% senior notes due 2016 in exchange for $122.2 million of its outstanding 6.375% debentures due 2009 and $42.6 million of its outstanding 7.20% debentures due 2009. The exchange was conducted as a private placement to holders of the existing debentures that were “qualified institutional buyers” within the meaning of Rule 144A of the Securities Act of 1933. As part of the exchange, the Company paid a premium of $15.6 million to holders participating in the exchange. The transaction was accounted for as an exchange of debt, and the $15.6 million premium will be amortized over the life of the new notes. The Company incurred financing transaction costs of $1.3 million related to the exchange of debt which were included in interest expense during the second quarter of 2005. In August 2005, the Company successfully completed a registered exchange offer in which all of the previously issued private notes were exchanged for substantially identical registered notes. The exchange of debt will reduce the Company’s interest costs prospectively and lengthens maturities on portions of the Company’s debt, reducing refinancing requirements in the near-term.
Cash Sources and Uses
The primary source of cash for the Company has been cash provided by operating activities. The primary uses of cash have been for capital expenditures, the repayment of debt maturities and capital lease obligations, the premium on the debt exchange, income tax payments and dividends.
A summary of activity for the first nine months of 2005 and the first nine months of 2004 follows:
Cash Sources
Cash provided by operating activities
Proceeds from redemption of life insurance policies
Total cash sources
Cash Uses
Capital expenditures
Repayment of debt and capital lease obligations
Dividends
Total cash uses
Increase (decrease) in cash
The Company made contributions to its pension plans of $8.0 million during the first nine months of 2005. The Company anticipates making total contributions to its pension plans of approximately $8 million to $10 million in 2005.
39
Based on current projections, which include a number of assumptions such as the Company’s pre-tax earnings, the Company anticipates its cash payments for income taxes will increase from approximately $6 million to $9 million in 2005 to an estimated $13 million to $17 million in 2006.
Investing Activities
Additions to property, plant and equipment during the first nine months of 2005 were $25.5 million compared to $38.6 million during the first nine months of 2004. Capital expenditures during the first nine months of 2005 were funded with cash flows from operations and from borrowings under the Company’s available lines of credit. Leasing is used for certain capital additions when considered cost effective relative to other sources of capital. The Company currently leases its corporate headquarters, two production facilities and several sales distribution facilities and administrative facilities.
At the end of the third quarter of 2005, the Company had no material commitments for the purchase of capital assets other than those related to normal replacement of equipment. The Company considers the acquisition of bottling territories on an ongoing basis. The Company anticipates that additions to property, plant and equipment in 2005 will be in the range of $40 million to $45 million and plans to fund such additions through cash flows from operations and its available lines of credit. The Company anticipates that additions to property, plant and equipment will be in the range of $60 million to $70 million in 2006.
Financing Activities
In June 2005, the Company issued $164.8 million of new 5.00% senior notes due 2016 in exchange for $122.2 million of its outstanding 6.375% debentures due 2009 and $42.6 million of its outstanding 7.20% debentures due 2009. As a result of the debt exchange, the Company reduced its near-term refinancing requirements by extending the maturity dates on a portion of its total debt.
On April 7, 2005, the Company entered into a new five-year $100 million revolving credit facility replacing the existing $125 million revolving credit facility that was scheduled to expire in December 2005. On October 2, 2005, there were no amounts outstanding under the new facility. The $100 million facility matures in April 2010. The new facility includes an option to extend the term for an additional year at the discretion of the participating banks. The new revolving credit facility bears interest at a floating base rate or a floating rate of LIBOR plus an interest rate spread of .375%. In addition, there is a facility fee of .125% required for this revolving credit facility. Both the interest rate spread and the facility fee are determined from a commonly used pricing grid based on the Company’s long-term senior unsecured noncredit-enhanced debt rating. The Company’s new revolving credit facility contains two financial covenants related to ratio requirements for interest coverage, and long-term debt to cash flow, each as defined in the credit agreement. These covenants do not currently, and the Company does not anticipate that they will, restrict its liquidity or capital resources.
The Company borrows periodically under its available lines of credit. These lines of credit, in the aggregate amount of $60 million at October 2, 2005, are made available at the discretion of the two participating banks at rates negotiated at the time of borrowing and may be withdrawn at any time by such banks. The Company can utilize its revolving credit facility in the event the lines of credit are not available. The Company had no amounts outstanding under its lines of credit as of October 2, 2005. To the extent that borrowings under the
40
lines of credit and borrowings under the revolving credit facility do not exceed the amount available under the Company’s revolving credit facility and the term of the revolving credit facility matures in more than 12 months, such borrowings are classified as noncurrent liabilities.
All of the outstanding long-term debt has been issued by the Company with none having been issued by any of the Company’s subsidiaries. There are no guarantees of the Company’s debt.
At October 2, 2005, the Company’s credit ratings were as follows:
Standard & Poor’s
Moody’s
The Company’s credit ratings are reviewed periodically by the respective rating agencies. Changes in the Company’s operating results or financial position could result in changes in the Company’s credit ratings. Lower credit ratings could result in higher borrowing costs for the Company. There were no changes in these credit ratings from the prior year. It is the Company’s intent to continue to reduce its financial leverage over time.
The Company’s public debt securities are not subject to financial covenants but do limit the incurrence of certain liens and encumbrances as well as indebtedness by the Company’s subsidiaries in excess of certain amounts.
The Company issued 20,000 shares of Class B Common Stock to J. Frank Harrison, III, Chairman of the Board of Directors and Chief Executive Officer, with respect to 2004, effective January 3, 2005, under a restricted stock award plan that provides for annual awards of such shares subject to the Company meeting certain performance criteria.
Off-Balance Sheet Arrangements
There has been no significant change in the Company’s off-balance sheet arrangements since January 2, 2005.
41
Aggregate Contractual Obligations
The following table summarizes the Company’s contractual obligations as of October 2, 2005:
After
Sept. 2010
Contractual obligations:
Capital lease obligations, net of interest
Purchase obligations (1)
Other long-term liabilities (2)
Operating leases
Long-term contractual arrangements (3)
Purchase orders (4)
Total contractual obligations
The Company is a member of Southeastern Container, a plastic bottle manufacturing cooperative, from which the Company is obligated to purchase at least 80% of its requirements of plastic bottles for certain designated territories. Such obligation is not included in the Company’s table of aggregate contractual obligations since there are no minimum purchase requirements.
Interest Rate Hedging
The Company periodically uses interest rate hedging products to modify risk from interest rate fluctuations. The Company has historically altered its fixed/floating rate mix based upon anticipated cash flows from operations relative to the Company’s debt level and the potential impact of changes in interest rates on the Company’s overall financial condition. Sensitivity analyses are performed to review the impact on the Company’s financial position and coverage of various interest rate movements. The Company does not use derivative financial instruments for trading purposes nor does it use leveraged financial instruments.
The Company currently has six interest rate swap agreements. These interest rate swap agreements effectively converted $250 million of the Company’s debt from a fixed rate to a floating rate and are accounted for as fair value hedges.
42
Interest expense was reduced due to amortization of deferred gains on previously terminated interest rate swap agreements and forward interest rate agreements by $1.3 million and $1.5 million during the first nine months of 2005 and the first nine months of 2004, respectively.
The weighted average interest rate of the Company’s debt and capital lease obligations after taking into account all of the interest rate hedging activities was 5.9% as of October 2, 2005 compared to 5.6% as of January 2, 2005 and 5.3% as of September 26, 2004. Approximately 42% of the Company’s debt and capital lease obligations of $779.7 million as of October 2, 2005 was maintained on a floating rate basis and was subject to changes in short-term interest rates.
If interest rates increased by 1%, the Company’s interest expense would increase by approximately $3.3 million over the next twelve months. This amount is determined by calculating the effect of a hypothetical interest rate increase of 1% on outstanding floating rate debt and capital lease obligations as of October 2, 2005, including the effects of our derivative financial instruments. This calculated, hypothetical increase in interest expense for the following twelve months may be different from the actual increase in interest expense from a 1% increase in interest rates due to varying interest rate reset dates on the Company’s floating rate debt and derivative financial instruments.
43
CAUTIONARY INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, as well as information included in future filings by the Company with the Securities and Exchange Commission and information contained in written material, press releases and oral statements issued by or on behalf of the Company, contains, or may contain, forward-looking management comments and other statements that reflect management’s current outlook for future periods. These statements include, among others, statements relating to:
44
These statements and expectations are based on the currently available competitive, financial and economic data along with the Company’s operating plans, and are subject to future events and uncertainties that could cause anticipated events not to occur or actual results to differ materially from historical or anticipated results. Among the events or uncertainties which could adversely affect future periods are:
45
The Company undertakes no obligation to publicly update or revise any forward-looking statements.
46
There has been no significant change in market risks since January 2, 2005.
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)), pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded, as of the end of the period covered by this report, that the Company’s disclosure controls and procedures were effective for the purpose of providing reasonable assurance that the information required to be disclosed in the reports the Company files or submits under the Exchange Act (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosures.
There has been no change in the Company’s internal control over financial reporting during the quarter ended October 2, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
47
PART II - OTHER INFORMATION
Description
48
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(REGISTRANT)
Date: November 10, 2005
Steven D. Westphal
Principal Financial Officer of the RegistrantandSenior Vice President and Chief Financial Officer
49