Title of Each Class
Name of Each Exchange on Which Registered
American Depositary Shares, each representing 10 Series L Shares, without par value
New York Stock Exchange, Inc.
Series L Shares, without par value
New York Stock Exchange, Inc. (not for trading, for listing purposes only)
8.95% Notes due November 1, 2006
Mexican GAAP
Net sales
$ 3,158.6
Ps. 35,486.8
Ps. 18,518.6
Ps. 17,636.5
Ps. 16,979.0
Ps. 15,205.9
Total revenues
3,180.2
35,729.4
18,667.5
17,771.6
17,052.7
15,253.9
Cost of sales
1,600.4
17,980.3
8,680.8
8,255.8
8,300.8
7,942.5
Gross profit
1,579.8
17,749.1
9,986.8
9,515.8
8,751.9
7,311.4
Operating expenses
982.5
11,038.7
5,319.3
5,351.0
5,405.5
4,819.9
Goodwill amortization
-
40.6
108.3
116.1
125.7
Income from operations
597.3
6,710.4
4,626.8
4,056.5
3,230.3
2,365.8
Net income
207.6
2,332.0
2,660.8
2,325.9
1,427.3
1,068.2
Majority net income
205.8
2,311.8
Majority income per share(3)
0.12
1.36
1.87
1.63
1.00
0.75
U.S. GAAP
Ps. 18,187.7
Ps. 17,273.5
Ps. 16,604.0
Ps. 16,791.0
18,320.6
19,237.2
19,030.4
17,755.0
Income from operations (4)
562.8
6,322.8
4,388.1
3,941.0
3,277.6
2,421.2
204.6
2,298.4
2,624.4
2,392.1
1,604.7
1,223.8
Net income per share (3)
1.35
1.84
1.68
1.13
0.86
Balance Sheet Data:
Total assets
$ 5,466.8
Ps. 61,419.8
Ps. 17,086.7
Ps. 15,116.8
Ps. 12,920.4
Ps. 12,040.4
Long-term debt
2,315.2
26,011.0
3,296.0
3,066.7
3,365.0
3,584.5
Capital stock
236.4
2,655.5
2,463.9
Majority stockholders’ equity
2,016.3
22,653.1
9,668.1
8,163.2
6,210.4
5,676.8
Total stockholders’ equity
2,030.8
22,816.6
(millions of unit cases)
Mexico
850.1
504.7
477.9
Central America
72.9
—
Colombia
114.1
Venezuela
110.1
Brazil
176.6
Combined Volume
1,450.5
620.3
607.8
Product Sales Volumes
Coca-Cola Trademark Beverages
99.6
93.3
Other Beverages
7.7
6.8
Total
107.3
100.1
% Growth
7.2
Unit Case Volume Mix by Category
(in percentages)
Colas
69.4
69.6
Flavored Soft Drinks
24.7
23.7
Total Carbonated Soft Drinks
94.1
Water
4.2
4.0
Other Categories
1.7
2.7
100.0
Product Mix by Presentation
Returnable
51.8
50.9
Non-returnable
42.9
43.4
Fountain
5.3
5.7
Jug
148.6
160.6
3.0
2.3
151.6
162.9
(6.9
57.0
48.2
29.2
34.0
86.2
82.2
Water(1)
8.2
10.6
5.6
36.4
39.1
57.6
52.5
3.3
5.4
206.1
239.5
59.0
83.1
265.1
322.6
(17.8
53.4
47.5
26.7
77.1
74.2
4.1
5.1
Other Categories(1)
18.8
20.7
11.1
11.9
85.1
84.1
3.8
126.6
115.6
9.5
71.4
68.3
27.4
30.4
98.8
98.7
0.9
0.8
0.3
0.5
24.5
12.4
71.8
82.9
3.7
4.7
Retailer Incentive Programs. Incentive programs include providing retailers with commercial refrigerators for the display and cooling of soft drink products and for point-of-sale display materials. We seek, in particular, to increase distribution coolers among retailers to increase the visibility and consumption of our products and to ensure that they are sold at the proper temperature. Sales promotions include sponsorship of community activities, sporting, cultural and social events, and consumer sales promotions such as contests, sweepstakes and product giveaways.
Advertising.We advertise in all major communications media. We focus our advertising efforts on increasing brand recognition by consumers and improving our customer relations. National advertising campaigns are designed and proposed by The Coca-Cola Company’s local affiliates, with our input at the local or regional level.
Channel Marketing. In order to provide more dynamic and specialized marketing of our products, our strategy is to segment our market and develop targeted efforts for each segment or distribution channel. Our principal channels are small retailers, “on-premise” consumption such as restaurants and bars, supermarkets and third party distributors. Presence in these channels entails a comprehensive and detailed analysis of the purchasing patterns and preferences of various groups of soft drink consumers in each of the various types of locations or distribution channels. In response to this analysis, we tailor our product, price, packaging and distribution strategies to meet the particular needs of and exploit the potential of each channel.
We believe that the implementation of our channel marketing strategy also enables us to respond to competitive initiatives with channel-specific responses as opposed to market-wide responses. This focused response capability isolates the effects of competitive pressure in a specific channel, thereby avoiding costlier market-wide responses. Our channel marketing activities are facilitated by our management information systems. We have invested significantly in creating such systems, including in hand-held computers to support the gathering of product, consumer and delivery information required to implement our channel marketing strategies effectively, for most of our sales routes in Mexico and Argentina, and will continue investing to increase pre-sale coverage in certain of our new territories.
Cooperative Marketing Budget. Our consolidated total marketing expenditure made in 2003 was Ps.1,498.4 million. In 2003 and 2002, The Coca-Cola Company contributed 48% and 41%, respectively, of our marketing expenditures budget. See “—Bottler Agreements.”
Product Distribution
The following table provides an overview of our product distribution centers and the retailers to which we sell our products:
Product Distribution SummaryAs of December 31, 2003
Argentina
Distribution Centers
113
43
42
38
10
4
Number of Retailers(1)
547,185
139,289
442,210
234,740
120,008
75,735
We use two main sales methods depending on market and geographic conditions: the traditional or conventional truck route system, in which the person in charge of the delivery makes immediate sales from inventory available on the truck, and the pre-sale system. The pre-sale program separates the sales and delivery functions, allowing sales personnel to sell products prior to delivery and enabling trucks to be loaded with the mix of products that retailers have previously ordered, thereby increasing distribution efficiency. Under the pre-sale program, sales personnel also provide merchandising services during retailer visits, which we believe enhances the presentation of our products at the point of sale. In certain areas we also make sales through third party wholesalers of our products. The vast majority of our sales are on a cash basis.
We believe that service visits to retailers and frequency of deliveries are essential elements in an effective selling distribution system for soft drink products. Accordingly, we have continued to expand our pre-sale system throughout our operations, except in areas where we believe consumption patterns do not warrant pre-sale. We are in the process of replicating our business model in our new territories.
Our distribution centers range from large warehousing facilities and re-loading centers to small deposit centers. In addition to our fleet of trucks, we distribute our products in certain locations through a fleet of electric carts and hand-trucks in order to comply with local environmental and traffic regulations. We generally retain third parties to transport our finished products from the bottler plants to the distribution centers.
Mexico. We contract with a subsidiary of FEMSA for the transportation of finished products to our distribution centers from our Mexican production facilities. See “Item 7. Major Shareholders and Related Party Transactions—Related Party Transactions.” From the distribution centers, we then distribute our finished products to retailers through our own fleet of trucks. In 2003, we implemented these practices in the newly acquired Mexican territories.
In Mexico, we sell a majority of our beverages at small retail stores to customers who take the beverages home or elsewhere for consumption. We also sell products through the “on-premise” segment, supermarkets and others. “On premise” consists of (i) sales through sidewalk stands, restaurants, bars and various types of dispensing machines and (ii) sales through point of sale programs in concert halls, auditoriums and theaters by means of a series of arrangements with Mexican promoters.
Central America. In Central America, we distribute our finished products to retailers through a combination of our own fleet of trucks and third party distributors.In Central America, excluding Guatemala, we sold more than 50% of sales volumes through the pre-sale system in 2003. In Guatemala, we sold only around 10% of sales volumes through pre-sale in 2003, but we currently plan to increase pre-sale coverage in the future. In our Central American operations, just as in most of our territories, an important part of our sales volumes are through small retailers, and we have low supermarket penetration in this region, representing less than 8% of sales volumes in 2003.
Colombia. Approximately half of sales volumes in Colombia are sold through pre-sale and half through the traditional system in 2003. We distribute our finished products to retailers through a combination of our own fleet of trucks and third party distributors. Since May 2003, we consolidated five distribution centers out of 47 in our Colombian operations, with the objective of increasing productivity levels and asset utilization.
Venezuela. In Venezuela close to 70% of our sales volumes in 2003 were through the pre-sale system. We distribute our finished products to retailers through a combination of our own fleet of trucks and third party distributors. During 2003 we consolidated the operations of two of the 40 distribution facilities. Our Venezuelan operations distribute a significant part of sales volumes through small retailers and supermarkets, which represent approximately 13% of our sales volumes in 2003.
Brazil. In Brazil, almost 100% of our direct sales volumes are through the pre-sale system, although the delivery of our finished products to customers is by a third party. At the end of 2003, we operated ten distribution facilities in our Brazilian territories. In contrast with the rest of our territories, which have low supermarket penetration,
in Brazil we sold more than 25% of our sales volume through supermarkets in 2003. In addition, in designated zones independent wholesalers purchase our products at a discount from the wholesale price and resell the products to retailers. Independent wholesalers distributed approximately 16% of our products in 2003.
Argentina. At December 31, 2003, we operated four distribution centers in Argentina. We distribute our finished products to retailers through a combination of our own fleet of trucks and third party distributors. Independent wholesalers distributed approximately 5.7% of our products in 2003.
In Argentina, in 2003 we sold the majority of our products in the take-home segment, which consists of sales to consumers who take the beverages home or elsewhere for consumption. In 2003, the percentage of sales volumes through supermarkets decreased to 17.9% from 23.4% in 2002.
Competition
Although we believe that our products enjoy wider recognition and greater consumer loyalty than those of our principal competitors, the soft drink segments in the territories in which we operate are highly competitive. Our principal competitors are local bottlers of Pepsi and other bottlers and distributors of national and regional soft drink brands. We face increased competition in many of our territories from producers of low price beverages, commonly referred to as “B” brands. A number of our competitors in Central America and Brazil also offer both soft drinks and beer, which may enable them to achieve distribution efficiencies.
During 2003, we faced new competitive pressures that are different than those we have historically faced as we began operations in Central America, Colombia, Venezuela and Brazil. In addition, distribution and marketing practices in some of these territories differ from our historical practices.
Recently, price discounting and packaging have joined consumer sales promotions, customer service and non-price retailer incentives as the primary means of competition among soft drink bottlers. We compete by seeking to offer an attractive price / value proposition to the different segments in our markets and by building on our brand equity. We believe that the introduction of new products and new presentations has been a significant competitive technique that allows us to increase demand for our products, provide different options to consumers and increase new consumption opportunities. See “—Sales Overview.”
Mexico. Our principal competitors in Mexico are bottlers of Pepsi products, whose territories overlap but are not co-extensive with our own. These competitors include Pepsi Gemex in central Mexico, a subsidiary of PBG, the largest bottler of Pepsi globally, and several other Pepsi bottlers in central and southeast Mexico. In addition, we compete with Cadbury Schweppes and with other national and regional brands in our Mexican segment. We also face an increase in competition from low price producers offering multi-serving size presentations in the soft drink industry.
Central America.In the countries that comprise our Central America segment, our main competitors are Pepsi bottlers. In Guatemala and Nicaragua we compete against The Central American Bottler Corporation, in Costa Rica our principal competitor is Embotelladora Centroamericana, S.A. and in Panama our main competitor is Refrescos Nacionales, S.A.
Colombia. Our principal competitor is Postobón S.A., which we refer to as Postobón, a well-established local bottler that sells flavored soft drinks, some of which have a wide consumption preference, such as cream soda, the second most popular category in the Colombian soft drink industry in terms of sales volumes, and Pepsi products. Postobón is a vertically integrated producer, the owners of which hold other significant commercial interests in Colombia.
Venezuela. In Venezuela, our main competitor is Pepsi-Cola Venezuela, C.A., a joint venture formed between PepsiCo and Empresas Polar, S.A., the leading beer distributor in the country. We also compete with the producers of Kola Real in part of the country.
Brazil. In Brazil, we compete against AmBev, a Brazilian company with a portfolio of brands that includes Pepsi, local brands with flavors such as guaraná and proprietary beers. We also compete against “B” brands or
“Tubainas,” which are small, local producers of low cost flavored soft drinks in multi-serving presentations that represent an important portion of the soft drink market.
Argentina. In Argentina, our main competitor is BAESA, a Pepsi bottler, which is owned by Argentina’s principal brewery, Quilmes Industrial S.A., and indirectly controlled by AmBev. In addition to BAESA, competition has intensified over the last several years with the entrance of a number of competitors offering generic, low priced soft drinks as well as many other generic products and private label proprietary supermarket brands.
Raw Materials
Pursuant to the bottler agreements with The Coca-Cola Company, we are required to purchase concentrate, including aspartame, an artificial sweetener used in diet sodas, for all Coca-Colatrademark beverages from companies designated by The Coca-Cola Company. The price of concentrate for all Coca-Cola trademark beverages is a percentage of the average price we charge to our retailers net of applicable taxes. Although The Coca-Cola Company has the right to unilaterally set the price of concentrates, in practice this percentage is set pursuant to periodic negotiations with The Coca-Cola Company. In connection with the Panamco acquisition, The Coca-Cola Company agreed that concentrate prices would not be raised through May 2004. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders—The Coca-Cola Memorandum.” In most cases, concentrate is purchased in the local currency of the territory.
In addition to concentrates, we purchase sweeteners, carbon dioxide, glass and plastic bottles, cans, closures and fountain containers, as well as other packaging materials. Our bottler agreements provide that, with respect to Coca-Cola trademark beverages, all containers, closures, cases, cartons and other packages and labels may be purchased only from suppliers approved by The Coca-Cola Company, which includes manufacturing subsidiaries of FEMSA Empaques. Prices for packaging materials historically are determined with reference to the U.S. dollar, although the local currency equivalent in a particular country is subject to price volatility in accordance with changes in exchange rates. Under our agreements with The Coca-Cola Company, we may use raw or refined sugar or HFCS as sweeteners in our products, although we currently use sugar in all of our operations except for Argentina. Sugar prices in all of the countries in which we operate, other than Brazil, are subject to local regulations and other barriers to market entry that cause us to pay in excess of international market prices for sugar. We have experienced sugar price volatility in these territories as a result of changes in local conditions and regulations.
None of the materials or supplies that we use are presently in short supply, although the supply of specific materials could be adversely affected by strikes, weather conditions, governmental controls or national emergency situations.
Mexico. We purchase some glass bottles, closures, plastic cases, commercial refrigerators, cans and certain lubricants and detergents for bottling lines from subsidiaries of FEMSA Empaques. We purchase our returnable plastic bottles from Continental PET Technologies de México, S.A. de C.V, a subsidiary of Continental Can, Inc., which has been the exclusive supplier of returnable plastic bottles to The Coca-Cola Company and its bottlers in Mexico. We purchase some of our non-returnable plastic bottles, as well as pre-formed plastic ingots for the production of non-returnable plastic bottles, from ALPLA Fábrica de Plásticos, S.A. de C.V., which we refer to as ALPLA, an authorized provider of PET for The Coca-Cola Company.
We purchase some can presentations from Industria Envasadora de Querétaro, S.A. de C.V., known as IEQSA, a bottler cooperative in which we hold 33.68% interest. Both we and IEQSA purchase a portion of our empty can supply requirements from Fábricas Monterrey, S.A. de C.V., known as Famosa, a subsidiary of FEMSA Empaques. Our supply agreements provide for market based pricing.
Sweeteners are combined with water to produce basic syrup, which is added to the concentrate as the sweetener for the soft drink. We regularly purchase sugar from Promotora Mexicana de Embotelladoras, S.A. de C.V., known as PROMESA, a cooperative of Coca-Colabottlers. These purchases are regularly made under one-year agreements between PROMESA and each bottler subsidiary for the sale of sugar at a price that is determined monthly based on the
cost of sugar to PROMESA. We also purchase sugar from Beta San Miguel, another sugar-cane producer in which we hold a 2.54% equity interest.
In December 2001, the Mexican government expropriated the sugar industry in Mexico. To administer this industry, the Mexican government entered into a trust agreement with Nacional Financiera, S.N.C., which we refer to as Nafin, a Mexican government-owned development bank, pursuant to which Nafin acts as trustee. In addition, the Mexican government imposed a 20% excise tax, effective January 1, 2002, on carbonated soft drinks sweetened with HFCS. As a result we converted our Mexican bottler facilities to sugar-cane-based production in early 2002. On January 1, 2003, the Mexican government broadened the reach of this tax by imposing a 20% excise tax on carbonated soft drinks produced with non-sugar sweetener, including HFCS. The effect of these excise taxes is to limit our ability to substitute other sweeteners for sugar.
Imported sugar is also presently subject to import duties, the amount of which is set by the Mexican government. As a result, sugar prices in Mexico are in excess of international market prices for sugar and increased by approximately 8% in 2003.
Central America. The majority of our raw materials such as glass and plastic bottles and cans are purchased from several local suppliers. Sugar is available from one supplier in each country. Local sugar prices are significantly higher than international market prices, and our ability to import sugar or HFCS is limited.
Colombia. We use sugar as a sweetener in our products, which we buy from several domestic sources. We purchase pre-formed ingots from a local supplier and Tapón Corona, in which we have a 40% equity interest. We purchase all our glass bottles and cans from suppliers, in which our competitor Postobón owns a 40% equity interest. Other suppliers exist for glass bottles, however, cans are available only from this one source.
Venezuela. We use sugar as a sweetener in our products, of which we purchase the majority from the local market and the rest we import mainly from Colombia. In the second half of 2003, there was a shortage of sugar due to the inability of the main sugar importers to access foreign currencies as a result of the exchange controls implemented at the beginning of 2003. We only buy glass bottles from one supplier, Productos de Vidrio, S.A., a local supplier, but there are other alternative suppliers authorized by The Coca-Cola Company. We have several supplier options for plastic non-returnable bottles but we acquire most of our requirements from ALPLA de Venezuela, S.A. One exclusive supplier handles all our can requirements.
Brazil. Sugar is widely available in Brazil at internal market prices which are generally lower than international prices. We purchase glass bottles, PET bottles and cans from several domestic and international suppliers.
Argentina.In Argentina, we use HFCS from several different local suppliers as sweetener in our products instead of sugar. We purchase glass bottles, plastic trays and other raw materials from several domestic sources. We purchase pre-formed plastic ingots, as well as returnable plastic bottles, at competitive prices from Complejo Industrial PET S.A., which we refer to as CIPET, a local subsidiary of Embotelladora Andina S.A., a Coca-Cola bottler with operations in Argentina, Chile and Brazil, and other international suppliers. We purchase crown caps from local and international suppliers. We purchase our can presentations for distribution to customers in Buenos Aires from Complejo Industrial CAN S.A., which we refer to as CICAN, in which Coca-Cola FEMSA de Buenos Aires has a 48.1% equity interest.
REGULATION
Price Controls. At present, there are no price controls on our products in any of our segments. In Mexico, prior to 1992, prices of carbonated soft drinks were regulated by the Mexican government. From 1992 to 1995, the industry was subject to voluntary price restraints. In response to the devaluation of the Mexican peso relative to the U.S. dollar in 1994 and 1995, however, the Mexican government adopted an economic recovery plan to control inflationary pressures in 1995. As part of this plan, the Mexican government encouraged the Asociación Nacional de Productores de Refrescos y Aguas Carbonatadas, A.C. (the National Association of Bottlers) to engage in voluntary consultations with the Mexican government with respect to price increases for returnable presentations. These voluntary consultations were terminated in 1996. In the last ten years, the governments in Colombia, Brazil, and Venezuela have also imposed formal price controls on soft drinks. The imposition of price controls in the future may limit our ability to set prices and adversely affect our results of operations.
Taxation of Soft Drinks.All the countries in which we operate impose a value-added tax on the sale of soft drinks, with a rate of 15% in Mexico, 12% in Guatemala, 15% in Nicaragua, 13% in Costa Rica, 5% in Panama, 16% in Colombia, 16% in Venezuela, 18% in Brazil (only in the territories where we operate) and 21% in Argentina. In addition, several of the countries in which we operate impose the following excise or other taxes:
Water Supply Law.In Mexico, we purchase water directly from municipal water companies and pump water from our own wells pursuant to concessions obtained from the Mexican government on a plant-by-plant basis. Water use in Mexico is regulated primarily by the Ley de Aguas Nacionales de 1992 (the Water Law of 1992),and regulations issued thereunder, which created the Comisión Nacional del Agua (the National Water Commission). The National Water Commission is charged with overseeing the national system of water use. Under the Water Law of 1992, concessions for the use of a specific volume of ground or surface water generally run for five-, ten- or fifteen-year terms, depending on the supply of groundwater in each region as projected by the National Water Commission. Concessionaires may request concession terms to be extended upon termination. The Mexican government is authorized to reduce the volume of ground or surface water granted for use by a concession by whatever volume of water is not used by the concessionaire for three consecutive years. However, because the current concessions for each of our plants in Mexico do not match each plant’s projected needs for water in future years, we successfully negotiated with the Mexican government the right to transfer the unused volume under concessions from certain plants to other plants anticipating greater water usage in the future. Our concessions may be terminated if, among other things, we use more water than permitted or we fail to pay required concession-related fees. We believe that we are in compliance with the terms of our existing concessions.
Although we have not undertaken independent studies to confirm the sufficiency of the existing or future groundwater supply, we believe that our existing concessions satisfy our current water requirements in Mexico. We can give no assurances, however, that groundwater will be available in sufficient quantities to meet our future production needs or that we will be able to maintain our current concessions.
We do not currently require a permit to obtain water in our other territories. In Nicaragua, Costa Rica and some plants in Colombia, we own private water wells. In Argentina, we obtain water from Aguas Argentinas, a privately-owned concessionaire of the Argentine government. In the remainder of our territories, we obtain water from governmental agencies or municipalities. In the past five years we have not had a water shortage in any of our territories, although we can give no assurances that water will be available in sufficient quantities to meet our future production needs or that additional regulations relating to water use will not be adopted in the future.
Environmental Matters.In all of the countries where we operate, our businesses are subject to federal and state laws and regulations relating to the protection of the environment. In Mexico, the principal legislation is the Ley General de Equilibrio Ecológico y Protección al Ambiente (the Federal General Law for Ecological Equilibrium and Environmental Protection) or the Mexican Environmental Law and the Ley General para la Prevención y Gestión Integral de los Residuos(the General Law for the Prevention and Integral Management of Waste) which are enforced by the Secretaría del Medio Ambiente, Recursos Naturales y Pesca (the Ministry of the Environment, Natural Resources and Fisheries) or SEMARNAP. SEMARNAP can bring administrative and criminal proceedings against companies that violate environmental laws, and it also has the power to close non-complying facilities. Under the Mexican Environmental Law, rules have been promulgated concerning water, air and noise pollution and hazardous substances. In particular, Mexican environmental laws and regulations require that we file periodic reports with respect to air and water emissions and hazardous wastes and set forth standards for waste water discharge that apply to our operations. We are also subject to certain minimal restrictions on the operation of delivery trucks in Mexico City. We have implemented several programs designed to facilitate compliance with air, waste, noise and energy standards established by current Mexican federal and state environmental laws, including a program that installs catalytic converters and liquid petroleum gas in delivery trucks for our operations in Mexico City. See “—The Company—Product Distribution.”
In addition, we are subject to the Ley Federal de Derechos (the Federal Law of Governmental Fees), also enforced by SEMARNAP. Adopted in January 1993, the law provides that plants located in Mexico City that use deep water wells to supply their water requirements must pay a fee to the city for the discharge of residual waste water to drainage. In 1995, municipal authorities began to test the quality of the waste water discharge and charge plants an additional fee for measurements that exceed certain standards published by SEMARNAP. All of our bottler plants located in Mexico City, as well as the Toluca plant, met these new standards in 2001, and as a result, we were not subject to additional fees. See “—Description of Property, Plant and Equipment—Production Facilities.”
Our Central American operations are subject to several federal and state laws and regulations relating to the protection of the environment, which have been enacted in the last ten years, as awareness has increased in this region about the protection of the environment and the disposal of dangerous and toxic materials. In some countries in Central America, we are in the process of bringing our operations into compliance with new environmental laws. For example, in Nicaragua we are in the final phase of the construction of a water treatment plant located at our bottler plant in Managua. Also, our Costa Rica operations have participated in a joint effort along with the local division of The Coca-Cola Company calledProyecto Planeta (Project Planet) for the collection and recycling of non-returnable plastic bottles.
Our Colombian operations are subject to several Colombian federal, state and municipal laws and regulations related to the protection of the environment and the disposal of toxic and dangerous materials. These laws include the control of atmospheric emissions and strict limitations on the use of chlorofluorocarbons. We are also engaged in nationwide campaigns for the collection and recycling of glass and plastic bottles.
Our Venezuelan operations are subject to several Venezuelan federal, state and municipal laws and regulations related to the protection of the environment. The most relevant of these laws are the Ley Orgánica del Ambiente (the Organic Environmental Law), the Ley Sobre Sustancias, Materiales y Desechos Peligrosos (the Substance, Material and Dangerous Waste Law), and the Ley Penal del Ambiente (the Criminal Environment Law). Since the enactment of the Organic Environmental Law in 1995, our Venezuelan subsidiary has presented to the proper authorities plans to bring our
production facilities and distribution centers into compliance with the law. While the laws provide certain grace periods for compliance with the new environmental standards, we have had to adjust some of the originally proposed timelines presented to the authorities, because of delays in the completion of some of these projects.
Our Brazilian operations are subject to several federal, state and municipal laws and regulations related to the protection of the environment. Among the most relevant laws and regulations are those dealing with the emission of toxic and dangerous gases, which impose penalties, such as fines, facility closures or criminal charges depending upon the level of non-compliance. Our production plant located in Jundiaí has been recognized by the Brazilian authorities for its compliance with environmental regulations and for having standards well above those imposed by the law. The plant has been certified for the ISO 9000 since March 1995 and the ISO 14001 since March 1997.
Our Argentine operations are subject to federal and provincial laws and regulations relating to the protection of the environment. The most significant of these are regulations concerning waste water discharge, which are enforced by the Secretaría de Recursos Naturales y Ambiente Humano (the Ministry of Natural Resources and Human Environment) and the Secretaría de Política Ambiental (the Ministry of Environmental Policy) for the province of Buenos Aires. Our Alcorta plant meets and is in compliance with waste water discharge standards.
We have expended, and may be required to expend in the future, funds for compliance with and remediation under local environmental laws and regulations. Currently, we do not believe that such costs will have a material adverse effect on our results of operations or financial condition. However, since environmental laws and regulations and their enforcement are becoming increasingly more stringent in our territories, and there is increased awareness of local authorities for higher environmental standards in the countries where we operate, changes in current regulations may result in an increase in costs, which may have an adverse effect on our future results of operations or financial condition. Management is not aware of any pending regulatory changes that would require a significant amount of additional remedial capital expenditures.
BOTTLER AGREEMENTS
Coca-Cola Bottler Agreements
Bottler agreements are the standard agreements that The Coca-Cola Company enters into with bottlers outside the United States for the sale of concentrates for certain Coca-Cola trademark beverages. We manufacture, package, distribute and sell soft drink beverages and bottled water under a separate bottler agreement for each of our territories.
These bottler agreements provide that we will purchase our entire requirement of concentrates for Coca-Colatrademark beverages from The Coca-Cola Company and other authorized suppliers at prices, terms of payment and on other terms and conditions of supply as determined from time to time by The Coca-Cola Company at its sole discretion. Concentrate prices are determined as a percentage of the weighted average wholesale price, net of applicable taxes. Although the price multipliers used to calculate the cost of concentrate and the currency of payment, among other terms, are set by The Coca-Cola Company at its sole discretion, we set the price of products sold to retailers at our discretion, subject to the applicability of price restraints. We have the exclusive right to distributeCoca-Cola trademark beverages for sale in our territories in authorized containers of the nature prescribed by the bottler agreements and currently used by our company. These containers include various configurations of cans and returnable and non-returnable bottles made of glass and plastic and fountain containers.
The bottler agreements include an acknowledgment by us that The Coca-Cola Company is the sole owner of the trademarks that identify the Coca-Cola trademark beverages and of the secret formulas with which The Coca-Cola Company’s concentrates are made. Subject to our exclusive right to distribute Coca-Cola trademark beverages in our territories, The Coca-Cola Company reserves the right to import and export Coca-Cola trademark beverages to and from each of our territories. Our bottler agreements do not contain restrictions on The Coca-Cola Company’s ability to set the price of concentrates charged to our subsidiaries and do not impose minimum marketing obligations on The Coca-Cola Company. The prices at which we purchase concentrates under the bottler agreements may vary materially from the prices we have historically paid. However, under our bylaws and the shareholders agreement with a subsidiary of The Coca-Cola Company and a subsidiary of FEMSA, an adverse action by The Coca-Cola Company under any of the bottler agreements may result in a suspension of certain veto rights of the directors, appointed by The Coca-Cola Company. This provides us with limited protection against The Coca-Cola Company’s ability to raise concentrate prices to the extent that such increase is deemed detrimental to us pursuant to the shareholder agreement and the bylaws. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders—The Shareholders Agreement.”
The Coca-Cola Company has the ability, at its sole discretion, to reformulate any of the Coca-Colatrademark beverages and to discontinue any of the Coca-Cola trademark beverages, subject to certain limitations, so long as all Coca-Colatrademark beverages are not discontinued. The Coca-Cola Company may also introduce new beverages in our territories in which case we have a right of first refusal with respect to the manufacturing, packaging, distribution and sale of such new beverages subject to the same obligations as then exist with respect to the Coca-Cola trademark beverages under the bottler agreements. The bottler agreements prohibit us from producing or handling cola products other than those of The Coca-Cola Company, or other products or packages that would imitate, infringe upon, or cause confusion with the products, trade dress, containers or trademarks of The Coca-Cola Company, or from acquiring or holding an interest in a party that engages in such activities. The bottler agreements also prohibit us from bottling any soft drink product except under the authority of, or with the consent of, The Coca-Cola Company. The bottler agreements impose restrictions concerning the use of certain trademarks, authorized containers, packaging and labeling of The Coca-Cola Company so as to conform to policies prescribed by The Coca-Cola Company. In particular, we are obligated to:
The Coca-Cola Company contributed approximately 48% of our advertising and marketing budget in our territories during 2003. Although we believe that The Coca-Cola Company intends to continue to provide funds for advertising and marketing, it is not obligated to do so. Consequently, future levels of advertising and marketing support provided by The Coca-Cola Company may vary materially from the levels historically provided. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders —The Shareholders Agreement.”
We have separate bottler agreements with The Coca-Cola Company for each of the territories in which we operate. Some of these bottler agreements renew automatically unless one of the parties gives prior notice that it does not wish to renew the agreement, while others require us to give notice electing to renew the agreement. The following table summarizes by segment the expiration dates and renewal provisions of our bottler agreements:
Segment
Expiration Date
Renewal Provision
The bottler agreements are subject to termination by The Coca-Cola Company in the event of default by us. The default provisions include limitations on the change in ownership or control of our company and the assignment or transfer of the bottler agreements and are designed to preclude any person not acceptable to The Coca-Cola Company from obtaining an assignment of a bottler agreement or from acquiring our company independently of similar rights set forth in the shareholders agreement. These provisions may prevent changes in our principal shareholders, including mergers or acquisitions involving sales or dispositions of our capital stock, which will involve an effective change of
control, without the consent of The Coca-Cola Company. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders —The Shareholders Agreement.”
We have also entered into tradename licensing agreements with The Coca-Cola Company pursuant to which we are authorized to use certain trademark names of The Coca-Cola Company. These agreements have an indefinite term, but are terminated if we cease to manufacture, market, sell and distribute Coca-Cola trademark products pursuant to the bottler agreements or if the shareholders agreement is terminated. The Coca-Cola Company also has the right to terminate the license agreement if we use its trademark names in a manner not authorized by the bottler agreements.
DESCRIPTION OF PROPERTY, PLANT AND EQUIPMENT
Over the past several years, we made significant capital improvements to modernize our facilities and improve operating efficiency and productivity, including:
See “Item 5. Operating and Financial Review and Prospects—Capital Expenditures.”
As of December 31, 2003, we owned 32 bottler plants company wide. By country, we have twelve bottler facilities in Mexico, four in Central America, six in Colombia, six in Venezuela, three in Brazil and one in Argentina.
Since the Panamco acquisition during 2003, we consolidated 20 of our plants into existing facilities, including four plants in Mexico, one in Central America, eleven in Colombia, three in Venezuela and one in Brazil. At the same time, we increased our productivity measured in unit cases sold by our remaining plants by more than 50% company wide.
As of December 31, 2003 we operated 250 distribution centers, more than 40% of which were in our Mexican territories. We own approximately 80% of these distribution centers and lease the remainder. See “The Company—Product Distribution.” During 2003, as part of our consolidation process, we reduced the number of our distribution centers across our territories by 37.
We maintain an “all risk” insurance policy covering our properties (owned and leased), machinery and equipment and inventories as well as losses due to business interruptions. The policy covers damages caused by natural disaster, including hurricane, hail, earthquake and damages caused by human acts, including explosion, fire, vandalism, riot and losses incurred in connection with goods in transit. In addition, we maintain an “all risk” liability insurance policy that covers product liability. We purchase our insurance coverage through an insurance broker. The policies are issued by Allianz and the coverage is partially reinsured in the international reinsurance market.
The table below summarizes principal use, installed capacity and percentage utilization of our production facilities by country:
Production Facility SummaryAs of December 31, 2003
Country
Principal Use
Installed Capacity(thousands of unit cases)
% Utilization(1)
Bottler Facility
1,417,345
59.5%
Guatemala
30,303
54.6%
Nicaragua
26,807
70.8%
Costa Rica
37,992
56.3%
Panama
28,830
36.1%
264,036
37.5%
268,763
42.1%
378,969
206,736
60.3%
The table below summarizes plant location and facility area of our production facilities:
Production Facility By LocationAs of December 31, 2003
SIGNIFICANT SUBSIDIARIES
The table below sets forth all of our direct and indirect significant subsidiaries and the percentage of equity of each subsidiary we owned directly or indirectly as of December 31, 2003:
Item 5. Operating and Financial Review and Prospects
General
The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, our consolidated financial statements including the notes thereto. Our consolidated financial statements were prepared in accordance with Mexican GAAP, which differ in certain significant respects from U.S. GAAP. Notes 25 and 26 to our consolidated financial statements provide a description of the principal differences between Mexican GAAP and U.S. GAAP as they relate to us, and a reconciliation to U.S. GAAP of majority net income, majority stockholders’ equity and certain other selected financial data.
Our consolidated financial statements include the financial statements of Coca-Cola FEMSA and those of all companies in which we own directly or indirectly a majority of the outstanding voting capital stock and/or over which we exercise control.
Acquisition of Panamco. On May 6, 2003, we completed the acquisition of Panamco. The acquisition of Panamco resulted in a substantial increase in the size and geographic scope of our operations. The purchase price for 100% of the capital stock of Panamco was Ps.29,518 million, excluding transaction expenses. We also assumed Ps.9,085 million of net debt. The acquisition was financed with an equity contribution from FEMSA of Ps.2,779 million, an exchange of The Coca-Cola Company’s equity interests in Panamco valued at Ps.7,041 million for new shares of our company, cash on hand of Ps.2,820 million and new indebtedness of Mexican pesos and U.S. dollars in the amount of Ps.17,267 million. As a result of the Panamco acquisition, in accordance with Mexican GAAP, we recognized as intangible assets with indefinite lives, the rights to produce and distribute trademark brands of The Coca-Cola Company. These identified intangibles, calculated as the difference between the price paid and the fair value of the net assets acquired, were valued at Ps.33,420 million, including financial and advisory fees, costs associated with closing certain acquired facilities, rationalizing and consolidating operations, relocating the corporate and other offices and the integration of the operations.
Comparability of Information Presented; Reporting Segments. Under Mexican GAAP, Panamco is included in our consolidated financial statements from May 2003 and is not reflected for periods prior to this date. As a result, our consolidated financial statements as of and for the year ended December 31, 2003 are not comparable to prior periods. Financial information provided by us with respect to the newly acquired territories is also not comparable to Panamco’s consolidated financial statements for prior periods as they were prepared using different policies and in accordance with U.S. GAAP and in U.S. dollars. These financial statements will also not be comparable to subsequent periods, as Panamco is only included in our consolidated financial statements for eight months of 2003.
For our consolidated financial statements for the years ended and as of December 31, 2001 and 2002, we reported Mexico and Argentina as separate reporting segments. For our consolidated financial statements for the year ended and as of December 31, 2003, we reported each of Mexico, Central America, Colombia, Venezuela, Brazil and Argentina as a separate reporting segment. Through our acquisition of Panamco, we acquired additional territories in Mexico, which are reported as part of our Mexico segment, as well as territories in Central America, Colombia, Venezuela and Brazil. We did not acquire any additional territories in Argentina, the segment information for which is fully comparable to prior periods.
Although our consolidated financial information is not comparable to prior periods, we maintain sales volume data for our territories on a basis comparable to that maintained by Panamco for prior periods. For comparison purposes, the following table presents sales volume by segment:
Year Ended December 31,
2003
2002
(millions ofunit cases)
(percentage)
Total Volumes:
1,001.6
54.9
980.5
5.9
171.8
9.4
185.0
9.9
8.3
8.7
14.5
17.3
7.0
6.2
1,824.0
1,866.7
The presented sales volume information is different from our actual sales volume. We have presented this information because these sales volumes are one of the metrics we use to manage our business. Sales volumes are discussed in greater detail by segment in “Item 4. Information on the Company—The Company—Sales Overview.”
Effects of Changes in Economic Conditions. Our results of operations are affected by changes in economic conditions in Mexico and in the other countries in which we operate. For the years ended December 31, 2003, 2002 and 2001, 66.7%, 90.6% and 89.1%, respectively, of our net sales were attributable to Mexico. Although after the Panamco acquisition, we have greater exposure to countries in which we have not historically conducted operations, particularly countries in Central America and Colombia, Venezuela and Brazil, we continue to generate a substantial portion of our revenues in Mexico.
Our future results may be significantly affected by the general economic and financial conditions in the countries where we operate. Decreases in economic growth rates, periods of negative growth, devaluation of local currencies, increases in inflation or interest rates and political developments may result in lower demand for our products, lower real pricing or a shift to lower margin products or lower margin presentations. Because a large percentage of our costs are fixed costs, we may not be able to reduce costs and expenses, and our profit margins may suffer as a result of downturns in the economy of each country. In addition, an increase in interest rates in Mexico would increase our cost of variable rate debt and Mexican peso-denominated funding and would have an adverse effect on our financial position and results of operations. A depreciation of the U.S. dollar would increase our cost of raw materials with prices payable in or determined with reference to the U.S. dollar and of debt obligations denominated in U.S. dollars, and thereby may negatively impact our results of operations.
Operating Leverage. Companies with structural characteristics that result in margin expansion in excess of sales growth are referred to as having high “operating leverage.” We are engaged in capital-intensive activities. The high utilization of the installed capacity of our production facilities results in better fixed cost absorption, as increased output results in higher revenues without additional fixed costs. Absent significant increases in variable costs, gross profit margins will expand when production facilities are operated at higher utilization rates. Alternatively, higher fixed costs will result in lower gross profit margins in periods of lower output.
In addition, our commercial operations are carried out through extensive distribution networks, the principal fixed assets of which are distribution centers and trucks. Our distribution systems are designed to handle large volumes of beverages. Fixed costs represent an important proportion of our total distribution expense. Generally, the higher the volume that passes through the distribution system, the lower the fixed distribution cost as a percentage of the corresponding revenues. As a result, operating margins improve when the distribution capacity is operated at higher utilization rates. In contrast, periods of decreased utilization because of lower volumes will negatively impact our operating margins.
Critical Accounting Estimates
The preparation of our consolidated financial statements requires that we make estimates and assumptions that affect (i) the reported amounts of our assets and liabilities, (ii) the disclosure of our contingent assets and liabilities as of the date of the financial statements and (iii) the reported amounts of revenues and expenses during the reporting period. We base our estimates and judgments on our historical experience and on various other reasonable factors, which together form the basis for making judgments about the carrying values of our assets and liabilities. Our actual results may differ from these estimates under different assumptions or conditions. We evaluate our estimates and judgments on an on-going basis. Our significant accounting policies are described in Notes 4 and 5 to our consolidated financial statements. We believe our most critical accounting policies that imply the application of estimates and/or judgments are:
Allowance for Doubtful Accounts.We determine our allowance for doubtful accounts based on an evaluation of the aging of our receivables portfolio. The amount of the allowance contemplates our historical loss rate on receivables and the economic environment in which we operate. Most of our sales, however, are realized in cash and do not give rise to doubtful accounts.
Bottles and Cases; Allowance for Bottle Breakage. We classify bottles and cases in accordance with industry practices as fixed assets. Breakage is expensed as incurred, and returnable bottles and cases are not depreciated. We determine depreciation of bottles and cases only for tax purposes.
We periodically compare the book breakage expense with calculated depreciation expense, estimating a useful life of four years for returnable glass bottles and one year for returnable plastic bottles and four years for returnable cases. These useful lives are determined in accordance with our business experience. Historically, the annual calculated depreciation expense has been similar to the annual book breakage expense. Whenever we decide to discontinue a particular returnable presentation and retire it from the market, we write-off the discontinued presentation through an increase in the breakage expense.
Property, Plant and Equipment.Property, plant and equipment are depreciated over their useful lives. The estimated useful lives represent the period we expect the assets to remain in service and to generate revenues. We base our estimates on independent appraisals and the experience of our technical personnel.
We describe the methodology used to restate imported equipment in Note 5(e) to our consolidated financial statements, which includes applying the exchange and inflation rates of the country of origin utilized as permitted by Mexican GAAP. We believe this method more accurately presents the fair value of the assets than restated cost determined by applying inflation factors.
We valued at fair value all fixed assets acquired in the Panamco transaction, considering their operational condition at the acquisition date and the future cash flows they will generate in accordance with our management’s estimated future use.
In 2003, after conducting an extensive analysis on the current conditions and expected useful lives of our refrigerator inventories in Mexico, we decided to modify the useful life of refrigerators in our original territories from three to five years. We made this decision based on the quality of our equipment as observed on a regular basis in point of sales locations and the benefit of our maintenance policy. As a result depreciation expense recorded in the 2003 income statement decreased approximately Ps.92 million. The useful life for refrigerators in the new territories acquired from Panamco is five years.
Valuation of Intangible Assets and Goodwill. As we discuss in Note 5(i) to our consolidated financial statements, beginning in 2003 we applied Bulletin C-8, Activos Intangibles (Intangible Assets), which established that project development costs should be capitalized if they fulfill the criteria established for recognition as assets. Additionally, Bulletin C-8 requires identifying all intangible assets to reduce as much as possible the goodwill associated with business combinations. Prior to 2003, the excess of the purchase price over the fair value of the net assets acquired in a business combination was considered to be goodwill. With the adoption of Bulletin C-8, we consider such excess to
relate to the rights to produce and distribute Coca-Colatrademark products. We separate intangible assets between those with a finite useful life and those with an indefinite useful life, in accordance with the period over which we expect to receive the benefits.
We valued at fair value all of Panamco’s assets and liabilities as of the date of the acquisition and, as required by Bulletin C-8, we conducted an analysis of the excess purchase price over the fair value of the net assets. The analysis resulted in the recognition of an intangible asset with indefinite life in the amount of Ps.33,420 for the right to produce and distribute Coca-Cola trademark products, which will be subject to annual impairment tests, under U.S. GAAP and Mexican GAAP. The fair value of the assets and liabilities was determined based on the following:
For Mexican GAAP purposes, goodwill is the difference between the price paid and the fair value of the shares and/or net assets acquired that was not assigned directly to an intangible asset. Goodwill and assigned intangible assets are recorded in the functional currency of the subsidiary in which the investment was made and is restated by applying the inflation rate of the country of origin and the year-end exchange rate. Goodwill is amortized over a period of not more than 20 years.
Under U.S. GAAP, SFAS No. 142, “Goodwill and Other Intangible Assets,” effective in 2002, goodwill is no longer subject to amortization, but instead is subject to an initial impairment review and subsequent impairment test. This test is performed annually unless an event occurs or circumstances change by which it becomes more likely than not that a reporting unit will reduce its fair value below its carrying amount, in which case an interim impairment test is performed. Our impairment review indicates that no impairment charge is required as of the beginning of 2004.
Impairment of Intangible Assets, Goodwill and Long-Lived Assets. We continually review the carrying value of our intangible assets, goodwill and long-lived assets for accuracy. We review for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable based on our projections of anticipated future cash flows. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect our evaluations.
In December 2001, the Argentine government adopted a series of economic measures, the most important of which consisted of restrictions on cash withdrawals and foreign exchange transactions. Due to the continuing difficult economic situation in Argentina, the uncertainty with respect to the period of recovery, and the instability of the exchange rate, on July 1, 2002, the company performed a valuation of its investment in Coca-Cola FEMSA de Buenos Aires, based on market price value multiples of comparable businesses. The valuation resulted in the recognition of an impairment of Ps.457 million, which was recorded in our 2002 results. Given the present economic situation in Argentina, we believe that the current net asset value of our foreign subsidiary is fairly valued, and although we can give you no assurances, we do not expect to recognize additional impairments in the future in Argentina.
Our evaluations throughout the year and up to the date of this filing did not lead to any other significant impairment of goodwill or long-lived assets. We can give no assurance that our expectations will not change as a result of new information or developments. Changes in economic or political conditions in all the countries in which we operate or in the industries in which we participate, however, may cause us to change our current assessment.
Labor Liabilities.Our labor liabilities are comprised of pension plan and seniority premiums. The determination of our obligations and expenses for pension and other post-retirement benefits depends on our selection of
certain assumptions used by actuaries in calculating such amounts. We evaluate our assumptions at least annually. Those assumptions are described in Note 15 to our consolidated financial statements and include, the discount rate, expected long-term rate of return on plan assets, rates of increase in compensation costs and certain employee-related factors, such as turnover, retirement age and mortality. The assumptions include the economic risk involved in the countries in which our business operates.
In accordance with Mexican GAAP, actual results that differ from our assumptions are accumulated and amortized over future periods and, therefore, generally affect our recognized expenses and recorded obligations in such future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension and other post-retirement obligations and our future expense.
The following table is a summary of the three key assumptions to be used in determining 2004 annual pension expense for Mexico, along with the impact on pension expense of a 1% change in each assumed rate:
New Accounting Pronouncements
Bulletin C-15, Deterioro en el Valor de los Activos de Larga Duración y su Disposición (Impairment of the Value of Long-Lived Assets and their Disposal): In March 2003, the Instituto Mexicano de Contadores Públicos (the Mexican Institute of Certified Public Accountants), which we refer to as the IMCP, issued Bulletin C-15, the application of which is mandatory for financial statements for periods beginning on or after January 1, 2004, although early application is encouraged. Bulletin C-15 establishes, among others, new principles for the calculation and recognition of impairment losses for long-lived assets and their reversal. The calculation of such loss requires the determination of the recoverable value, which is now defined as the greater of the net selling price of a cash-generating unit and its value in use, which is the present value of discounted future net cash flows. The accounting principles issued prior to this new bulletin used future net cash flows, without requiring the discounting of such cash flows. We do not anticipate that this new standard will have a significant impact on our financial position or results of operations.
Bulletin C-12, Instrumentos Financieros con Características de Pasivo, de Capital o de Ambos (Financial Instruments with Characteristics of Debt, Equity or Both): In April 2003, the IMCP issued Bulletin C-12, the application of which is mandatory for financial statements for periods beginning on or after January 1, 2004, although early
application is encouraged. Bulletin C-12 establishes the more significant differences between debt and equity, as the basis for the development of the criteria necessary to appropriately identify, classify and record, upon initial recognition, the debt and equity components of compound financial instruments. This new pronouncement is similar to SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” of U.S. GAAP. We do not anticipate that this new standard will have a significant impact on our financial position or results of operations.
SFAS No 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities” (which we refer to as SFAS No. 149): In April 2003, the FASB issued SFAS No. 149, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other agreements and for hedging activities under SFAS No. 133. The changes in this statement improve financial reporting by requiring that agreements with comparable characteristics be accounted for similarly. The new standard will be effective for agreements entered into or modified after September 30, 2003, except as stated below and for hedging relationships designated after September 30, 2003. In addition, except as stated below, all provisions of this statement should be applied prospectively.
The provisions of this statement that relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to September 15, 2003 should continue to be applied in accordance with their respective effective dates. We do not anticipate that this new standard will have a significant impact on our financial position or results of operations.
FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (which we refer to as FIN 46): In January 2003, the FASB issued FIN 46. FIN 46 clarified the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective immediately for all variable interests held in a variable interest entity created after January 31, 2003. For a variable interest held in a variable interest entity created before February 1, 2003 we would be required to apply the provisions of FIN 46 as of December 31, 2004. We do not currently have any variable interests in a variable interest entity.
Results of Operations
The following table sets forth our consolidated income statement for the years ended December 31, 2003, 2002 and 2001:
Results of Operations by Segment
The following table sets forth certain financial information for each of our segments for the years ended December 31, 2003, 2002 and 2001. For the years ended December 31, 2002 and 2001, we reported our results of operations in two segments, Mexico and Argentina. See Note 24 to our consolidated financial statements for additional information by segment.
Results of Operations for the Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002.
Consolidated Results of Operations
Net Sales. Consolidated net sales grew by 91.6% to Ps.35,486.8 in 2003, from Ps.18,518.6 in 2002, as a result of the inclusion of sales from the newly acquired territories for eight months of 2003 as well as increases in sales in our previously existing territories in Mexico and Argentina. Consolidated sales volumes increased to 1,450.5 million unit cases for 2003. Consolidated average unit price per case decreased by 18.1% from Ps.29.86 in 2002 to Ps.24.46 in 2003 due to the inclusion of the newly acquired territories, which had higher sales volumes of less profitable products.
Other Operating Revenues. Other operating revenues increased by 62.9% to Ps.242.6 million in 2003, from Ps.148.9 million in 2002. Other operating revenues mainly consist of sales to other bottlers pursuant to tolling arrangements in Argentina, revenues from sales of recyclable scrap to bottle suppliers and sales of point of sales materials for the fountain business.
Cost of Sales. Cost of sales increased to Ps.17,980.3 million in 2003, from Ps.8,680.8 million in 2002, as a result of the inclusion of the newly acquired territories for eight months of 2003. As a percentage of total sales, cost of sales increased 3.8%, reflecting the higher costs of sales in the newly acquired territories mainly due to the different product mix and higher manufacturing costs. We were also affected by the impact of the devaluation of the U.S. dollar against the Mexican peso as applied to our raw materials with prices that are paid in or determined with reference to the U.S. dollar.
The components of cost of sales include raw materials (principally soft drink concentrate, packaging materials, sweeteners and water), depreciation expenses attributable to our production facilities, wages and other employment expenses associated with the labor force employed at our production facilities and certain overhead expenses. Concentrate prices are determined as a percentage of the retail price of our products net of applicable taxes. See “Item 4. Information on the Company—The Company—Raw Materials.”
Operating Expenses.Consolidated operating expenses were Ps.11,038.7 million in 2003, as a result of the inclusion of the newly acquired territories for eight months of 2003. As a percentage of total sales, operating expenses increased 2.4%, due to the standardization of marketing practices in the newly acquired territories and the fact that distribution costs in our new territories are higher than in our original territories.
We incur various expenses related to the distribution of our products. We include these types of costs in the selling expenses line of our income statement. During 2003 and 2002, our distribution costs amounted to Ps.2,803.6 million and Ps.2,099.0 million, respectively. The exclusion of these charges from our cost of sales line may result in the amounts reported as gross profit not being comparable to other companies, which may include all expenses related to their distribution network in cost of sales when computing gross profit (or an equivalent measure).
Goodwill Amortization.We did not recognize goodwill amortization in 2003. In May of 2003 we considered the excess of the purchase price over the fair value of the net assets acquired in the Panamco acquisition, related to the rights to produce and distributeCoca-Cola trademark products, as intangible assets with an indefinite useful life. These intangible assets with indefinite lives are not amortized, but are periodically subject to an impairment test.
Income from Operations.Consolidated income from operations after amortization of goodwill grew to Ps.6,710.4 million in 2003, from Ps.4,626.8 million in 2002. Income from operations as a percentage of total revenues decreased 6% in 2003, from 24.8% to 18.8%, mainly as a result of the inclusion of our new territories, which had lower operating margins.
Integral Result of Financing.The term “integral result of financing” refers to the combined financial effects of net interest expense or interest income, net foreign exchange gains or losses and net gains or losses on monetary position. Net foreign exchange gains or losses represent the impact of changes in foreign exchange rates on assets or liabilities denominated in currencies other than local currencies. A foreign exchange loss arises if a liability is denominated in a foreign currency that appreciates relative to the local currency between the date the liability is incurred or the beginning of the period, whichever comes first, and the date it is repaid or the end of the period, whichever comes first, as the appreciation of the foreign currency results in an increase in the amount of local currency which must be exchanged to repay the specified amount of the foreign currency liability. The gain or loss on monetary position refers to the impact of local inflation on monetary assets and liabilities.
In 2003, we reported a loss of Ps.2,481.5 million from integral result of financing, as compared to a gain of Ps.560.3 million in 2002. This loss principally reflects our new financial position after the Panamco acquisition, and the combined effect of:
Other Expenses. Other expenses decreased from Ps.614.2 in 2002 to Ps.238.6 in 2003 mainly as a result of the impairment recorded in 2002 related to the Argentine operations.
Income Taxes and Employee Profit Sharing. Income taxes and employee profit sharing decreased from Ps.1,912.1 million in 2002 to Ps.1,658.2 million in 2003. The company’s consolidated effective income tax and employee profit sharing rate remained 41.6% in 2003, reflecting the Mexican effective tax rate of 44.0% that is applied to Mexican income before taxes, which comprised the majority of our taxable income during 2003.
Net Income. Consolidated net income decreased by 12.4% in 2003 to Ps.2,332.1 from Ps.2,660.8. Net income per share was Ps.1.36 (U.S.$1.21 per ADS) in 2003 computed on the basis of 1,704.3 million compounded average shares outstanding during 2003.
Consolidated Results of Operations by Geographic Segment
Net Sales. Net sales in Mexico increased to Ps.23,683.2 million in 2003, from Ps.16,774.9 million in 2002, principally as a result of the inclusion of the newly acquired territories for eight months of 2003. Sales volumes in Mexico grew to 850.1 million unit cases during 2003 from 504.7 million unit cases in 2002.Although most of this growth in sales volumes is a result of the inclusion of the newly acquired territories, volume growth was also driven by:
The effect of these volume increases on our net sales was mitigated by a lower average real price per unit case in Mexico, which decreased to Ps.27.86 in 2003, mainly due to the incorporation of jug water volumes with a much lower cost per unit from the newly acquired territories and to a lesser extent by the increased size of multi-serving presentations.
Income from Operations.Gross profit totaled Ps.12,844.5 million, reaching a 53.7% margin as a percentage of total revenues in 2003. Higher raw materials prices, the effect of the devaluation of the Mexican peso versus the U.S. dollar on our raw materials with prices payable in or determined with reference to the U.S. dollar, a softer economy and a lower disposable income, amplified by a migration to multi-serving presentations from individual size presentations resulted in declining margins in 2003. During 2003, we eliminated Panamco’s former headquarters in Mexico City and Miami, closed four plants out of 16, consolidated 29 distribution centers out of 142, introduced more than 73,000 new coolers into the market and reconfigured pre-sale and distribution networks by reducing third party selling and distribution. Operating income totaled Ps.5,633.6 million in 2003, reaching a 23.5% margin as a percentage of total revenues.
Net Sales. Net sales in Central America were Ps.2,182.6 million for 2003. During this period, our average real price per unit case was Ps.29.93. Sales volumes in Central America in 2003 were driven by:
Higher volumes from our core brands in returnable presentations as well as volumes sold in non-returnable PET bottles contributed to the results during the year.
Income from Operations.Gross profit totaled Ps.1,087.9 million in 2003, reaching a 49.8% gross margin as a percentage of total revenues during the same period. Procurement and other cost reduction initiatives offset cost increases of U.S. dollar-denominated packaging costs during the year. We closed one of our two plants in Panama, and consolidated two distribution centers in the region. Operating income totaled Ps.218.4 million, reaching an operating income margin of 9.9% as a percentage of total revenues. We believe our Central American territories will present opportunities for us to develop a more effective returnable packaging base, new product alternatives and improve execution practices. In Guatemala, however, we face a strong competitive environment combined with a higher than normal cost structure.
Net Sales.Net sales in Colombia were Ps.2,319.1 million for 2003. During this period, our average real price per unit case was Ps.20.32. Sales volumes were weak during this period as a result of:
Income from Operations.Gross profit totaled Ps.1,068.1 million, reaching a 46.1% gross margin as a percentage of total revenues during the same period. Lower volumes, higher packaging costs and the impact of the devaluation of the Colombian peso versus the U.S. dollar, applied to U.S. dollar denominated expenses resulted in declining margins. During 2003, we implemented a strong asset consolidation program intended to increase the efficiency of our manufacturing network. We converted 11 manufacturing plants out of 17 into distribution facilities from May 2003 to February 2004 and also consolidated five distribution centers as part of our strategy to face a tough competitive environment. Operating income was Ps.261.1 million, reaching an 11.3% margin as a percentage of total revenues during 2003.
Net Sales. Net sales in Venezuela were Ps.2,542.2 million for 2003. During this period, our average real price per unit case was Ps.23.08. Sales volumes in Venezuela were adversely affected by:
We were able to mitigate some of this decline by implementing an asset rationalization strategy intended to increase the efficiency of our manufacturing network during the year. Sales volumes improved slightly at the end of 2003 as a result of our packaging and revenue management strategies. Volume growth from the Coca-Cola brand increased and partially offset the volume decline of carbonated soft drink flavors during the year.
Income from Operations.Gross profit totaled Ps.1,105.9 million in 2003, reaching a 43.4% gross margin as a percentage of total revenues during the same period. Political unrest, combined with a devaluation of the bolivar against the U.S. dollar applied to our raw materials that are payable or are determined with reference to the U.S. dollar, and a severe decline in the economic activity in the country, resulted in a contraction of more than 10% of the country’s gross domestic product, which was only partially offset by price increases during the year. We consolidated our production facilities from nine to six and closed two distribution facilities in 2003. Operating income was Ps.231.5 million, reaching an operating income margin of 9.1% during 2003.
Net Sales.Net sales in Brazil were Ps.2,785.8 million in 2003. During this period, our average real price per unit case was Ps.15.77. In 2003, we undertook an initiative to use in-house pre-sale and to rely less on third party wholesalers in order to have more control over the point of sale and to permit us to implement packaging management strategies. We launched more than ten different SKUs to target different consumption occasions, including Coca-Cola com Limãoand Kuat laranja (guaraná flavor with orange). Traditionally in Brazil, most of our consumption came from only two packaging alternatives, cans and 2.0-liter bottles. We are now focusing on a broader array of presentations to spur consumer demand. For example, our new 12-ounce non-returnable glass bottle and our new 200-milliliter returnable glass bottle offer a combination of convenience and affordability for on-premise consumption of Coca-Cola.Our new 2.25-liter and 3.0-liter non-returnable PET presentations for carbonated soft drink flavors and the Coca-Cola brand, respectively, provide packaging alternatives and permit selling strategies between the supermarket and small retailers opening a road to implement our segmentation and revenue management initiatives.
Income from Operations.Gross profit totaled Ps.1,011.0 million in 2003, reaching a 36.1% margin as a percentage of total revenues. The implementation of new commercialization and point of sale development strategies improved our packaging and product mix during the year. We consolidated one plant out of four during 2003. Operating income was Ps.149.8 million, reaching an operating income margin of 5.4% during 2003.
Net Sales.Net sales in Argentina increased by 13.2% in 2003 to Ps.1,973.9 million from Ps.1,743.8 million in 2002. During 2003, our average real price per unit case increased by 3.4% in 2003 to Ps.15.59 from Ps.15.08, as a result of price increases implemented during the year and a change of mix toward our core brands in returnable presentations and our premium brands, which have the highest average prices per unit.
Sales volumes in Argentina increased 9.5% to 126.6 million unit cases in 2003, from 115.6 million unit cases in 2002. We believe the principal volume drivers in Argentina in 2003 were our returnable packaging strategy and the economic recovery from the devaluation of the Argentine peso in 2002. We also experienced a product shift from our less profitable value protection brands, Taí and Crush, toward our core brands, Coca-Cola and Fanta, which increased 15.1% and 40.6% in terms of sales volumes, respectively, and for the first time, more sales from premium brands than from value protection brands, fostered by a 10.9% volume increase of the Coca-Cola light brand and the successful introduction of Fanta light during the year.
Income from Operations.Gross profit totaled Ps.767.6 million during 2003, reaching a gross margin of 37%, an improvement of 2.6% as compared to 2002. This improvement was mainly driven by (i) higher sales volume, (ii) higher average prices per unit case, and (iii) an appreciation of the Argentine peso versus the U.S. dollar applied to U.S. dollar-denominated raw materials and expenses. In Argentina, operating expenses as a percentage of total revenues decreased 4.4% from 31% in 2002 to 26.6% in 2003, mainly as a result of the appreciation of the Argentina peso versus the U.S. dollar applied to expenses payable in or determined with reference to the U.S. dollar and strict cost control measures. Operating income during 2003 in our Argentine territories reached Ps.215.6 million and operating margin rose from 2.9% during 2002 to 10.4% in 2003.
Results of Operations for the Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001.
Net Sales. Consolidated net sales grew by 5% in 2002, principally reflecting growth in Mexico, which more than offset a decrease in net sales in Argentina.
Other Operating Revenues.Other operating revenues increased by 10.2% in 2002, to Ps.148.9 million. The increase primarily reflects revenues obtained from toll production agreements in Argentina with neighboring Coca-Cola bottlers, whereby we produce beverages for sales in their territories.
Cost of Sales.The components of cost of sales include raw materials (principally sweeteners, soft drink concentrate, packaging materials and water), depreciation expenses attributable to our production facilities, wages and other employment expenses associated with the labor force employed at our production facilities and certain overhead expenses. Concentrate prices, which are payable in local currency, are determined as a percentage of the retail price of our products net of applicable taxes. See “Item 4. Information on the Company—The Company—Raw Materials.” As a percentage of total revenues, cost of sales remained unchanged during 2002 as compared to 2001 at 46.5%.
Operating Expenses.Consolidated operating expenses decreased by 0.6% in 2002 as compared to 2001 and by 1.6% compared as a percent of total revenues (to 28.5% from 30.1%). The decrease, in absolute terms, resulted from a 3.7% decline in selling expenses, which offset an 8.6% increase in administrative expenses. The increase in administrative expenses was due in part to increases in payroll taxes in Mexico following new legislation adopted at the beginning of the year.
We incur various expenses related to the distribution of our products. We include these types of costs in the selling expenses line of our income statement. During 2002 and 2001, our distribution costs amounted to Ps.2,099.0 million and Ps.2,236.4 million, respectively. The exclusion of these charges from our cost of sales line may result in the amounts reported as gross profit not being comparable to other companies that may include all expenses related to their distribution network in cost of sales when computing gross profit (or an equivalent measure).
Goodwill Amortization.Goodwill amortization for 2002 was Ps.40.7 million, compared to Ps.108.3 million for 2001. Due to the uncertainty and instability of the economic environment in Argentina, during the third quarter of 2002, we wrote down Ps.457.2 million of the goodwill generated by the acquisition of our territories in Argentina. This non-cash impairment charge was recorded under “other expense, net,” in our consolidated income statement. Under Mexican GAAP, the remaining value of goodwill will continue to be amortized in the income statement.
Income from Operations. Consolidated income from operations after amortization of goodwill grew by 14.1% to Ps.4,626.8 million in 2002. Operating income as a percentage of total revenues increased by 2% in 2002, from 24.8% to 22.8%. This increase primarily reflects a decrease in operating expenses, a 2.9% increase in the average price per unit case, a slight reduction in cost of sales per unit case and lower goodwill amortization expenses because of a non-cash impairment charge to goodwill relating to our operations in Argentina in July 2002.
Integral Result of Financing.The term “integral result of financing” refers to the combined financial effects of net interest expense or interest income, net foreign exchange gains or losses and net gains or losses on monetary position. Net foreign exchange gains or losses represent the impact of changes in foreign exchange rates on assets or liabilities denominated in currencies other than local currency. A foreign exchange loss arises if a liability is denominated in a foreign currency that appreciates relative to the local currency between the date the liability is incurred or the beginning of the period, whichever comes first, and the date it is repaid or the end of the period, whichever comes first, as the appreciation of the foreign currency results in an increase in the amount of local currency which must be exchanged to repay the specified amount of the foreign currency liability. The gain or loss on monetary position refers to the impact of inflation on monetary assets and liabilities.
In 2002, we reported income of Ps.560.3 million from integral result of financing, as compared to a loss of Ps.129.6 million in 2001. This improvement principally reflects:
These factors more than offset an increase in net interest expenses of Ps.28.7 million, which reflects primarily a slight increase in interest expenses generated by the devaluation of the Mexican peso against the U.S. dollar and a decrease in interest income generated by a reduction in interest rates as applied to our cash balances.
Until June 30, 2002, we calculated foreign exchange losses or gains on the U.S. dollar liabilities incurred in connection with the acquisition of our Argentine territories, only with respect to the un-hedged portion of such liabilities. According to Mexican GAAP, the investment in our Argentine territories was designated as a hedge to the indebtedness incurred. As of June 30, 2002, the dollar-denominated outstanding liabilities relating to the acquisition of our Argentine territories amounted to U.S.$300 million and the net investment in our Argentine territories was U.S.$118.1 million, resulting in un-hedged liabilities of U.S.$181.5 million. Since July 2002, we discontinued using our investment in our Argentine territories as a hedge. We determined that our current operations in Argentina do not represent a natural hedge of these liabilities given the current volatility of the exchange rate between the Argentine peso and the U.S. dollar and the elimination of the one-to-one parity between those currencies. The Audit Committee of our board of directors approved this determination.
Other Expenses.Other expenses increased significantly from Ps.44.1 million in 2001 to Ps.614.2 million in 2002, mainly as a result of the Ps.457.2 million impairment recognized during the third-quarter of 2002 in connection with the goodwill generated by the acquisition of our Argentine operations and severance payments in connection with the restructuring of certain of our operations in Mexico and Argentina.
Income Taxes and Employee Profit Sharing. Income taxes and employee profit sharing increased from Ps.1,526.7 million in 2001 to Ps.1,912.1 million in 2002. The company’s consolidated effective income tax and employee profit sharing rate increased from 39.3% in 2001 to 41.8% in 2002. In 2002, our effective tax rate increased because the impairment charge mentioned above is non-deductible for tax purposes. Excluding that charge, our effective tax rate in 2002 would have been 38.3%.
Net Income. Consolidated net income increased by 14.4% to Ps.2,660.8 in 2002, resulting in earnings per share of Ps.1.87 (U.S.$ 0.17 per ADS).
Consolidated Results Operations by Geographic Segment
Net Sales.Net sales grew by 6.7% in Mexico. During 2002, our average real price per unit case increased by 1.1%, mainly due to price increases implemented in central Mexico during February 2002. Sales volumes in Mexico grew by 5.6% to 504.7 million unit cases during 2002 and represented 81.3% of our consolidated sales volume. During 2002, as compared to 2001, sales volume in Mexico:
The following chart sets forth sales volumes and average unit price per case for 2002, as well as percent growth over 2001 in Mexico:
We believe that the principal volume drivers in Mexico in 2002 were:
Income from Operations.Gross profit totaled Ps.9,359.2 million, reaching a gross margin of 55.6% in 2002 compared to a margin of 54.7% in 2001 due to a greater absorption of fixed costs driven by sales volume growth. Operating expenses decreased slightly as a percentage of total revenues by 120 basis points to 28.2%. This reflects primarily a decrease of 1.3 percentage points in selling expenses as a percentage of total revenues. Administrative expenses remained unchanged as a percentage of total revenues. Income from operations during 2002 reached Ps.4,597.4 million with an operating margin of 27.3%, an increase of 25.2% from 2001.
Net Sales.Net sales in Argentina decreased by 9.1% in 2002, despite an 11% decline in sales volume. In Argentina, our average real price per unit case increased by 2.1% in 2002, as a result of a 67% weighted average price increase implemented during the year that offset the effect of inflation and a change in mix to returnable packages which generate a lower price per unit. The 11% decline in sales volumes reflects continued economic uncertainty in Argentina.
We responded to the challenges presented by the Argentine market in 2002 with the objective of defending the equity of our brands, regaining market presence from “B” brands, extracting positive cash flow and reducing our cost structure. As the year progressed, our commercial strategies yielded a more favorable outcome, closing the year with volume growth of 3% in the fourth quarter of 2002. Our principal commercial strategy was shifting the mix towards returnable packages, which increased from 5.8% of the mix in 2001 to 12.4% in 2002. The shift was led by the 1.25-liter glass returnable presentation of Coca-Cola, Fanta and Sprite, which was introduced in the second quarter of 2002 and represented 16.6% of our sales volume in Argentina during the fourth quarter of 2002.
Income from Operations.Gross profit totaled Ps.627.6 million, reaching a gross margin of 34.4% in 2002 compared to a margin of 44.2% in 2001. Cost of sales as a percentage of total revenues during 2002 increased 9.8 percentage points to 65.6%. These results are due to lower absorption of fixed costs driven by volume decline, higher prices for raw materials, particularly those with prices quoted in U.S. dollars, and higher depreciation resulting from the restatement to year-end values of foreign currency denominated assets following the significant devaluation of the Argentine peso. Selling expenses decreased by 25.9%, a reduction of 5.8 percentage points as a percentage of total revenues resulting from lower marketing expenses and headcount reduction combined with adjustments in salaries. Administrative expenses in Argentina increased by 17.2% as a result of higher depreciation resulting mostly from the
restatement to year-end values of the leases of our computer equipment recorded in foreign currencies, following the significant devaluation of the Argentine peso. Income from operations during 2002 reached Ps.29.4 million with an operating margin of 1.6%, a decline of 2.2 percentage points as compared to 2001, as a result of an 11% decline in sales volume combined with higher administrative expenses.
Liquidity and Capital Resources
Liquidity. The principal source of our liquidity is cash generated from operations. A significant majority of our sales are on a cash basis with the remainder on a short-term credit basis. We have traditionally been able to rely on cash generated from operations to fund our working capital requirements and our capital expenditures. Our working capital benefits from the fact that we make our sales on a cash basis, while we generally pay our suppliers on credit. In addition to cash generated from operations, we have used new borrowings to fund acquisitions of new territories. We have relied on a combination of borrowings from Mexican and international banks, borrowings in the international capital markets and, more recently, borrowings in the Mexican capital markets.
As a result of the Panamco acquisition, our total indebtedness was Ps.29,004 million as of December 31, 2003, as compared to Ps.3,306 million as of December 31, 2002. Cash and cash equivalents were Ps.2,783 million as of December 31, 2003, as compared to Ps.6,429 million as of December 31, 2002. Approximately U.S.$43 million of cash is subject to restrictions as a result of certain collateral arrangements we have entered into on behalf of our subsidiaries with respect to existing indebtedness.
As part of our financing policy, we expect to continue to finance our liquidity needs from cash from operations. Nonetheless in the future we may be required to finance our working capital and capital expenditure needs with short-term or other borrowings. As a result of regulations in certain countries in which we operate, it may not be beneficial or, as in the case of exchange controls in Venezuela, practicable for us to remit cash generated in local operations to fund cash requirements in other countries. In the event that cash from operations in these countries is not sufficient to fund future working capital requirements and capital expenditureswe may decide, or be required, to fund cash requirements in these countries through local borrowings rather than remitting funds from another country. As of December 31, 2003, we had U.S. dollar-denominated, uncommitted approved lines of credit totaling approximately Ps.2,944 million, of which Ps.2,039 million was available as of such date. In December 2003, we finalized a loan agreement with The Coca-Cola Company that permits us to borrow, upon the satisfaction of certain conditions, U.S.$250 million prior to December 20, 2006 for funding working capital needs and for other general corporate purposes at any time when such funding is not otherwise available under our existing lines of credit.
We continuously evaluate opportunities to pursue acquisitions or engage in joint venture or other transactions.We would expect to finance any significant future transactions with a combination of cash from operations, long-term indebtedness and capital stock of our company.
Sources and Uses of Cash.The following table summarizes the sources and uses of cash for the three years ended December 31, 2003:
Contractual Obligations
The table below sets forth our contractual obligations as of December 31, 2003:
Debt Structure
On December 31, 2003, we had cash and cash equivalents of Ps.2,783.2 million (U.S.$247.7 million), total short term debt of Ps.2,963 million (U.S.$263.7 million) and long term debt of Ps.26,041.3 million (U.S.$2,317.8 million). The following chart sets forth the current debt breakdown of the company and its subsidiaries by currency and interest rate type as of December 31, 2003:
Summary of Significant Debt Instruments
The following is a brief summary of our significant long-term indebtedness with restrictive covenants outstanding as of December 31, 2003:
9.40% Senior Unsecured Notes Due 2004. On August 26, 1994, we entered into a note purchase agreement pursuant to which we issued 9.40% Senior Unsecured Notes due 2004 in the amount of U.S.$100 million. The note purchase agreement imposes certain conditions on a consolidation or merger by us and restrictions on liens, sale and leaseback transactions, assets sales and subsidiary indebtedness. We are also required to maintain a ratio of consolidated net borrowings to consolidated net worth and a minimum level of net worth. In addition, upon a change of control, which is defined as the failure of The Coca-Cola Company to hold at least 25% of our capital stock with voting rights, we are required to make an offer to prepay the notes at their face value.
8.95% Notes Due 2006. On October 28, 1996, we entered into an indenture pursuant to which we issued 8.95% Notes due 2006 in the amount of U.S.$200 million. The indenture imposes certain conditions upon a consolidation or merger by us and restricts the incurrence of liens and sale and leaseback transactions. In addition, upon a change of control, which is defined as the failure of The Coca-Cola Company to hold at least 25% of our capital stock with voting rights, we are required to make an offer to repurchase the notes at their face value.
7.25% Notes Due 2009. On July 11, 1997, our subsidiary Panamco issued 7.25% Senior Notes Due 2009, of which U.S.$290 million remain outstanding as of December 31, 2003. We guaranteed these notes on October 15, 2003. The indenture imposes certain conditions upon a consolidation or merger by us or Panamco and restricts the incurrence of liens and sale and leaseback transactions by Panamco.
Term Loans.On April 23, 2003, we entered into a Term Loan Agreement pursuant to which we borrowed:
The Term Loan Agreement contains restrictions on liens, fundamental changes such as mergers and certain asset sales and our ability to incur restrictions on the ability of our subsidiaries to pay dividends and subsidiary indebtedness. In addition, we are required to maintain a minimum interest expense coverage ratio and comply with a maximum leverage ratio. Finally, there is an event of default upon a change of control, which is defined as the failure of The Coca-Cola Company to hold at least 25% of our capital stock with voting rights.
Certificados Bursátiles. During 2003, we established a program for and issued the following certificados bursátiles in the Mexican capital markets:
The certificados bursátiles contain restrictions on the incurrence of liens and accelerate upon the occurrence of an event of default, including a change of control, which is defined as the failure of The Coca-Cola Company to hold at least 25% of our capital stock with voting rights.
We believe we are currently in compliance with all of our restrictive covenants, although a significant and prolonged deterioration in our consolidated results of operations could cause us to cease to be in compliance under certain indebtedness. We can provide no assurances that we will be able to incur indebtedness in the future or to refinance existing indebtedness on similar terms.
Off-balance SheetArrangements
We do not have any off-balance sheet arrangements.
Contingencies
We have various loss contingencies, for which reserves have been recorded in those cases where we believe the results of an unfavorable resolution is probable. See “Item 8—Financial Information—Consolidated Statements and Other Financial Information—Legal Proceedings.” Most of these loss contingencies have been recorded as reserves against intangibles. Any amounts required to be paid in connection with these loss contingencies would be required to be paid from available cash.
Capital Expenditures
The following table sets forth our capital expenditures (before sales of property, plant and equipment) for the periods indicated on a consolidated and by segment basis:
Our capital expenditures in 2003 focused on integration of our new territories, placing refrigeration equipment with retailers and investments in returnable bottles and cases, increasing plant operating efficiencies, improving the efficiency of our distribution infrastructure and advancing information technology. Through these measures, we strive to improve our profit margins and overall profitability.
In connection with the continued integration of our new territories, we estimated that our capital expenditures in 2004 would be approximately of Ps.3,300 million. Our capital expenditures in 2004 are primarily intended for:
We estimate that a majority of our projected capital expenditures for 2004 will be spent in our Mexican territories. We believe that internally generated funds will be sufficient to meet our budgeted capital expenditure for 2004. Our capital expenditure plan for 2004 may change based on market and other conditions and our results of operations and financial resources. Our ability to incur new indebtedness is limited. See “—Liquidity and Capital Resources—Liquidity” and “—Contractual Obligations.” We also expect to incur other cash costs in connection with the integration of our new territories in order to reduce our overall costs in the future. We also expect to finance these costs with cash from operations.
Historically, The Coca-Cola Company has contributed to our capital expenditure program. We generally utilize these contributions for the placement of refrigeration equipment with customers and other volume driving initiatives that promote volume growth of Coca-Colatrademark beverages. Such payments may result in a reduction in our selling expenditures. Contributions by The Coca-Cola Company are made on a discretionary basis. Although we believe that The Coca-Cola Company will make additional contributions in the future to assist our capital expenditure program, we can give no assurance that any such contributions will be made.
We continuously evaluate opportunities to pursue acquisitions or engage in joint ventures or other transactions. The consummation of any of these opportunities may require us to make significant investments or capital expenditures.
Hedging Activities
Our business activities require the holding or issuing of derivative instruments to hedge our exposure to market risks related to changes in interest rates, foreign currency exchange rates, equity risk and commodity price risk. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”
The following table provides a summary of the fair value of derivative instruments as of December 31, 2003. The fair market value is obtained mainly from external sources, which are our counterparties to the contracts.
U.S. GAAP Reconciliation
The principal differences between Mexican GAAP and U.S. GAAP that affect our net income and stockholders’ equity relate to the accounting for:
A more detailed description of the differences between Mexican GAAP and U.S. GAAP as they relate to us and a reconciliation of net majority income and majority shareholders’ equity under Mexican GAAP to net income and shareholders’ equity under U.S. GAAP is contained in Notes 25 and 26 to our consolidated financial statements.
Pursuant to Mexican GAAP, our consolidated financial statements recognize certain effects of inflation in accordance with Bulletins B-10 and B-12. These effects were not reversed in the reconciliation to U.S. GAAP.
Under U.S. GAAP, we had net income of Ps.2,298.4 million in 2003, Ps.2,624.4 million in 2002 and Ps.2,392.1 million in 2001. Net income as reconciled to U.S. GAAP was lower than net income as reported under Mexican GAAP by Ps.13.4 million in 2003, lower by Ps.36.4 million in 2002 and higher by Ps.66.2 million in 2001.
Shareholders’ equity under U.S. GAAP was Ps.22,048.9 million in 2003, Ps.9,294.4 million in 2002 and Ps.8,208.5 million in 2001. Compared to Mexican GAAP, shareholders’ equity under U.S. GAAP was Ps.604.2 million lower in 2003, Ps.373.7 million lower in 2002 and Ps.45.3 million higher in 2001.
Item 6. Directors, Senior Management and Employees
Directors
Management of our business is vested in our board of directors. Our bylaws provide that our board of directors will consist of at least eighteen directors elected at the annual ordinary shareholders’ meeting for renewable terms of one year. Our board of directors currently consists of 18 directors and 18 alternate directors. The directors are elected as follows: 11 directors and their respective alternate directors are elected by holders of the Series A Shares voting as a class; four directors and their respective alternate directors are elected by holders of the Series D Shares voting as a class; and three directors and their respective alternate director are elected by holders of the Series L Shares voting as a class. A director may only be elected by a majority of shareholders of the appropriate series, voting as a class, represented at the meeting of shareholders.
In addition, holders of any series of our shares that do not vote in favor of the directors elected, either individually or acting together with other dissenting shareholders of any series, are entitled to elect one additional director and the corresponding alternate director for each 10% of our outstanding capital stock held by such individual or group. Any directors and alternate directors elected by dissenting shareholders will be in addition to those elected by the majority of the holders of Series A Shares, Series D Shares and Series L Shares.
Our bylaws provide that the board of directors shall meet at least four times a year. Actions by the board of directors must be approved by at least a majority of the directors present and voting, which (except under certain circumstances) must include at least two directors elected by the Series D shareholders. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders—The Shareholders Agreement.”
See “Item 7. Major Shareholders and Related Party Transactions—Related Party Transactions” for information on relationships with certain directors and senior management.
As of March 15, 2004, our board of directors had the following members (including alternate directors):
Series A Directors
Eugenio Garza Lagüera is the Honorary (non-voting) Life Chairman of our board of directors. The Secretary of the board of directors is Carlos Eduardo Aldrete Ancira and the Alternate Secretary of the board is David A. González Vessi.
Statutory Examiners
Under Mexican law, a statutory examiner must be elected by the shareholders at the annual ordinary shareholders’ meeting for a term of one year. We currently have two statutory examiners, one elected by the holders of Series A Shares and one by the holders of Series D Shares, and two alternate statutory examiners, one elected by the holders of Series A Shares and one by the holders of Series D Shares. Mexican law also requires that the statutory examiners receive periodic reports from our board of directors regarding material aspects of our affairs, including our financial condition. The primary role of the statutory examiners is to report to our shareholders at the annual ordinary shareholders’ meeting on the accuracy of the financial information presented to such statutory examiners by the board of directors. Our Series A statutory examiner is Ernesto González Dávila and our Series D statutory examiner is Fausto
Sandoval Amaya. Our alternate Series A statutory examiner is Ernesto Cruz Velázquez de León and our alternate Series D statutory examiner is Humberto Ortíz Gutiérrez.
Executive Officers
As of March 15, 2004, the following are the principal executive officers of our company:
Compensation of Directors and Officers
For the year ended December 31, 2003, the aggregate compensation of all of our executive officers paid or accrued in that year for services in all capacities was approximately Ps.124.3 million, of which approximately Ps.54.8 million was paid in the form of cash bonus awards. The aggregate compensation amount also includes bonuses paid to certain of our executive officers pursuant to the stock incentive plan. See “—Stock Incentive Plan”.
For each meeting attended, we paid Ps.30,000 to each director during 2002 and the first quarter of 2003, and Ps.35,000 beginning in the second quarter of 2003. Beginning in 2003 we paid the Audit Committee members Ps.120,000 per year, and each of the Finance and the Compensation Committees members Ps.14,000 per year. The aggregate compensation for directors during 2003 was Ps.3.2 million.
Our senior management and executive officers participate in our benefit plan on the same basis as our other employees. Members of our board of directors do not participate in our benefit plan. As of December 31, 2003, amounts
set aside or accrued for all employees under these retirement plans were Ps.786.5 million, of which Ps.206.4 million is already funded.
Stock Incentive Plan
The bonus program for executive officers is based upon the accomplishment of certain critical factors, established annually by management. The bonus is paid in cash the following year based on the accomplishment of these goals.
From 1999 to 2003, we instituted a compensation plan for certain key executives, that consisted of granting them an annual bonus in FEMSA and Coca-Cola FEMSA stock or options, based on each executive’s responsibilities within the organization and his or her performance. Executives receiving bonuses had access to the assigned stocks or options in 20% increments in each of the five years following the granting of the bonus, beginning one year after they were granted. The five-year program ended in 2003, the last year shares were assigned. We are in the process of designing a new plan that will be effective in 2004 and that we expect will have the same general terms as the prior plan.
EVA-Based Stock Incentive Plan
Beginning in 2004 we plan to commence a new three-year stock incentive plan for the benefit of our executive officers, which we refer to as the EVA Stock Incentive Plan. This new plan replaces the Stock Incentive Plan described above and is being developed using as the main metric for evaluation the Economic Value Added (or EVA) framework developed by Stern Stewart & Co., a compensation consulting firm. Under the proposed terms of the EVA Stock Incentive Plan, eligible executive officers will be entitled to receive a special cash bonus, which will be used to purchase a stock grant on the Mexican stock exchange.
Based on the current proposed structure for the plan, each year our Chief Executive Officer, in conjunction with our Evaluation and Compensation Committee, will determine the amount of the special cash bonus used to purchase the stock grant. This amount will be determined based on each executive officer’s level of responsibility and based on the EVA generated by us.
We intend for the stock grants to be administrated by certain trusts for the benefit of the selected executive officers in the same manner as in the previous Stock Incentive Plan. Under the proposed terms of the EVA Stock Incentive Plan, each time a special bonus is assigned to an executive officer, the executive officer will contribute the special bonus received to the administrative trust in exchange for a stock grant. Pursuant to the proposed plan, the administrative trust will acquire a specified proportion of BD Units of FEMSA and Series L Shares of Coca-Cola FEMSA in the open market using the special bonus contributed by each executive officer. The ownership of the BD Units of FEMSA and the Series L Shares of Coca-Cola FEMSA will vest upon the executive officer holding a stock grant each year over the next five years following the date of receipt of the stock grant, at a rate per year equivalent to 20% of the number of BD Units of FEMSA and Coca-Cola FEMSA Series L Shares, as applicable.
Share Ownership
As of March 15, 2004, several of our directors and alternate directors serve on the Technical Committee as Trust Participants under the Irrevocable Trust No. F/29487-6 established at BBVA Bancomer, S.A., as Trustee, which is the owner of 69.7% of the voting stock of FEMSA, which in turn owns 45.7% of our outstanding capital stock. As a result of the Technical Committee’s internal procedures, the Technical Committee procedures, the Technical Committee as a whole is deemed to have beneficial ownership with sole voting power of all the shares deposited in the voting trust, and the Trust Participants, as Technical Committee members, are deemed to have beneficial ownership with shared voting power over those same deposited shares. These directors and alternate directors are Eugenio Garza Lagüera, Alfonso Garza Garza, Mariana Garza de Treviño and Eva Garza Gonda de Fernández. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders.” None of our other directors, alternate directors or executive officers is the beneficial owner of more than 1% of any class of our capital stock.
Board Practices
Our bylaws state that the board of directors will meet at least four times a year, following the end of each quarter, to discuss our operating results and progress in achieving strategic objectives. Our board of directors can also hold extraordinary meetings. See “Item 10. Additional Information—Bylaws.”
Under our bylaws, directors serve one-year terms although they continue in office until successors are appointed. None of our directors or senior managers of our subsidiaries has service agreements providing for benefits upon termination of employment.
Our board of directors is supported by committees, which are working groups that analyze issues and provide recommendations to the board of directors regarding their respective areas of focus. The executive officers interact periodically with the committees to address management issues. The following are the three committees of the board of directors:
Employees
As of December 31, 2003, our headcount, including employees of third party distributors that work for us, was as follows: 25,683 in Mexico, 5,402 in Central America, 8,466 in Colombia, 8,159 in Venezuela, 6,217 in Brazil and 2,914 in Argentina. The table below sets forth headcount (excluding third parties) by category for the periods indicated:
337
201
154
15,032
5,245
5,350
As of December 31, 2003, we almost tripled the number of employees as compared to 2002, due to the acquisition of Panamco. Approximately 61% of our personnel, most of whom were employed in Mexico, were members of labor unions. We had 57 separate collective bargaining agreements with four labor unions represented at our Mexican operations and several agreements with different labor unions in the rest of the countries where we operate. In general, we have a good relationship with the labor unions throughout our operations, except for in Colombia and Venezuela, which are the subjects of significant labor-related litigation. See “Item 8. Financial Information—Consolidated Statements and Other Financial Information—Legal Proceedings.” We believe we have appropriate reserves for these litigations and do not currently expect them to have a material adverse effect.
Insurance Policies
We maintain insurance policies for all of our non-union employees. These policies mitigate the risk of having to pay death benefits in the event of an industrial accident. We maintain directors’ and officers’ insurance policies covering all directors and certain key executive officers for liabilities incurred in their capacities as directors and officers.
Item 7. Major Shareholders and Related Party Transactions
MAJOR SHAREHOLDERS
Our capital stock consists of three classes of securities: Series A Shares held by FEMSA, Series D Shares held by The Coca-Cola Company and Series L Shares, held by the public. The following table sets forth our major shareholders as of March 15, 2004:
In addition, as of March 15, 2004, 98,840,861 authorized but unissued Series L Shares are held in treasury.
FEMSA and The Coca-Cola Company have reached an agreement pursuant to which, at FEMSA’s request, FEMSA may purchase sufficient shares from The Coca-Cola Company to increase its ownership of our capital stock to 51%. See “—Coca-Cola Memorandum.”
Our Series A Shares, owned by FEMSA, are held in Mexico and our Series D Shares, owned by The Coca-Cola Company, are held outside of Mexico.
As of December 31, 2003, there were 24,920,542 of our ADSs outstanding, each ADS representing ten Series L Shares. Approximately 92% of our outstanding Series L Shares were represented by ADSs. As of March 15, 2004, approximately 91% of our outstanding Series L Shares were represented by ADSs, held by approximately 260 holders (including The Depositary Trust Company) with registered addresses outside of Mexico.
The Shareholders Agreement
In connection with the initial subscription by a subsidiary of The Coca-Cola Company of our capital stock, FEMSA and The Coca-Cola Company agreed that we would be managed as a joint venture. Accordingly, in June of 1993, a subsidiary of FEMSA and a subsidiary of The Coca-Cola Company entered into a shareholders agreement, which, together with our bylaws, sets forth the basic rules under which we operate. This agreement has been
subsequently amended to reflect changes in the subsidiaries through which FEMSA and The Coca-Cola Company hold their shares of our company.
The shareholders agreement contemplates that we will be managed in accordance with one-year and five-year business plans, although in practice, we are now managed according to a three-year plan.
Under our bylaws, our Series A Shares and Series D Shares are the only shares with full voting rights and, therefore, control actions by our shareholders and board of directors. The holders of Series A Shares and Series D Shares have the power to determine the outcome of all actions requiring approval by our board of directors and, except in certain limited situations, all actions requiring approval of the shareholders. For actions by the board of directors, a supermajority including the directors appointed by the holders of Series D Shares is required for all actions. For shareholder actions, a majority of the shares represented at the shareholder meeting must vote in favor, whereas to amend the voting or quorum rights set out in the bylaws, a supermajority of at least 95% of those voting and not abstaining, must vote in favor.
The shareholders agreement sets forth the principal shareholders’ understanding as to the effect of adverse actions of The Coca-Cola Company under the bottler agreements. Our bylaws provide that a majority of the directors appointed by the holders of Series A Shares, upon making a reasonable, good faith determination that any action of The Coca-Cola Company under any bottler agreement between The Coca-Cola Company and our company or any of our subsidiaries is materially adverse to our business interests and that The Coca-Cola Company has failed to cure such action within 60 days of notice, may declare a simple majority period at any time within 90 days after giving notice. During the simple majority period certain decisions, namely the approval of material changes in our business plans, the introduction of a new, or termination of an existing, line of business, and related party transactions outside the ordinary course of business, which would ordinarily require the presence and approval of at least two Series D directors, can be made by a simple majority vote of our entire board of directors, without requiring the presence or approval of any Series D director. A majority of the Series A directors may terminate a simple majority period but, once having done so, cannot declare another simple majority period for one year after the termination. If a simple majority period persists for one year or more, the provisions of the shareholders agreement for resolution of irreconcilable differences may be triggered, with the consequences outlined in the following paragraph.
In addition to the rights of first refusal provided for in our bylaws regarding proposed transfers of Series A Shares or Series D Shares, the shareholders agreement contemplates three circumstances under which one principal shareholder may purchase the interest of the other in our company: (i) a change in control in a principal shareholder; (ii) the existence of irreconcilable differences between the principal shareholders; or (iii) the occurrence of certain specified defaults.
In the event that (i) one of the principal shareholders buys the other’s interest in our company in any of the circumstances described above or (ii) the ownership of our shares of capital stock other than the Series L Shares of the subsidiaries of The Coca-Cola Company or FEMSA is reduced below 20% and upon the request of the shareholder whose interest is not so reduced, the shareholders agreement requires that our bylaws be amended to eliminate all share transfer restrictions and all super-majority voting and quorum requirements, after which the shareholders agreement would terminate. In the event that the ownership of our shares of capital stock other than the Series L Shares of the subsidiaries of The Coca-Cola Company or FEMSA is reduced below 25% (but not below 20%) and upon the request of the shareholder whose interest is not so reduced, the shareholders agreement requires that our bylaws be amended to eliminate all super-majority voting and quorum requirements, other than those relating to the share transfer restrictions.
The shareholders agreement also contains provisions relating to the principal shareholders’ understanding as to our growth. It states that it is The Coca-Cola Company’s intention that we will be viewed as one of a small number of its “anchor” bottlers in Latin America. In particular, the parties agree that it is desirable that we expand by acquiring additional bottler territories in Mexico and other Latin American countries in the event any become available through horizontal growth. In addition, The Coca-Cola Company has agreed, subject to a number of conditions, that if it obtains ownership of a bottler territory that fits with our operations, it will give us the option to acquire such territory. The Coca-Cola Company has also agreed to support prudent and sound modifications to our capital structure to support horizontal growth. The Coca-Cola Company’s agreement as to horizontal growth expires upon either the elimination of
the super-majority voting requirements described above or The Coca-Cola Company’s election to terminate the agreement as a result of a default.
The Coca-Cola Memorandum
In connection with the acquisition of Panamco, we established certain understandings primarily relating to operational and business issues with both The Coca-Cola Company and FEMSA that were memorialized in writing prior to completion of the acquisition. The terms are as follows:
RELATED PARTY TRANSACTIONS
FEMSA
We regularly engage in transactions with FEMSA and its subsidiaries. In 2003, we purchased crown caps, plastic bottle caps, cans, commercial refrigerators, lubricants, detergents, plastic cases and substantially all of our returnable glass bottle requirements for our Mexican operations from FEMSA Empaques, a wholly-owned subsidiary of FEMSA, under several supply agreements. A subsidiary of FEMSA Empaques also sells refrigerators to our non-Mexican operations. The aggregate amount of these purchases was Ps.1,513.0 million in 2003. We believe that our purchasing practices with FEMSA Empaques result in prices comparable to those that would be obtained in arm’s length negotiations with unaffiliated parties. We also sell products to a chain of convenience stores owned by FEMSA under the name OXXO. These transactions are also conducted on an arm’s length basis.
We entered into a service agreement in June 1993 with FEMSA Servicios, S.A. de C.V., a wholly owned subsidiary of FEMSA which we refer to as FEMSA Servicios, pursuant to which FEMSA Servicios provides certain administrative services relating to insurance, legal and tax advice for a period of at least one year, cancelable thereafter by either party, and certain limited administrative and auditing services for as long as FEMSA maintains an interest in our company. This agreement was made on terms that we believe to be commercially reasonable.
In November 2000, we entered into a service agreement with a subsidiary of FEMSA for the transportation of finished products from our production facilities to our distribution centers within Mexico. In 2003, we paid approximately Ps.410.3 million pursuant to this agreement. See “Item 4. Information on the Company—The Company—Product Distribution.” This agreement was made on terms that we believe to be commercially reasonable.
In November 2001, we entered into two franchise bottler agreements with Promotora de Marcas Nacionales, an indirect subsidiary of FEMSA, under which we became the sole franchisee for the production, bottling, distribution and sale of Mundetbrands in the valley of Mexico and in most of our operations in the southeast of Mexico. Each franchise agreement has a term of ten years and will expire in November 2011. Both agreements are renewable for ten-year terms, subject to non-renewal by either party with notice to the other party. The total payments made to Promotora de Marcas Nacionales were Ps.61.8 million.
FEMSA is also a party to the understandings we have with The Coca-Cola Company relating to specified operational and business issues that may affect us following completion of the Panamco acquisition. A summary of these understandings is set forth under “—Major Shareholders—The Coca-Cola Memorandum.”
The Coca-Cola Company
We regularly engage in transactions with The Coca-Cola Company and their affiliates. Our company and The Coca-Cola Company pay and reimburse each other for marketing expenditures under a cooperative marketing arrangement. In each of 2003 and 2002, The Coca-Cola Company contributed approximately 48% and 41%, respectively of our marketing budget, totaling approximately Ps.1,371.8 million and Ps.521.6 million, respectively. In addition, The Coca-Cola Company has made payments to us in connection with cold-drink equipment investment and other volume driving investment programs. In each of 2002 and 2001, The Coca-Cola Company also contributed to our refrigerator equipment investment program. We purchase all of our concentrate requirements for Coca-Colatrademark beverages from The Coca-Cola Company. Total payments by us to The Coca-Cola Company for concentrates were approximately Ps.5,613.6 million and Ps.2,725.2 million in 2003 and 2002, respectively.
Coca-Cola FEMSA de Buenos Aires also purchases a portion of its plastic ingot requirements for producing plastic bottles and all of our returnable bottle requirements from CIPET. CIPET is a local subsidiary of Embotelladora Andina, a Coca-Cola bottler with operations in Argentina, Chile and Brazil in which The Coca-Cola Company has a substantial interest.
In connection with the acquisition of Panamco, subsidiaries of The Coca-Cola Company made specified undertakings to support and facilitate the Panamco acquisition for the benefit of our company. In consideration for these undertakings, we made certain undertakings for the benefit of The Coca-Cola Company and its subsidiaries, including indemnity obligations with respect to specified matters relating to the accuracy of disclosure and the compliance with applicable law by our board of directors and the board of directors of Panamco and undertakings to take specified actions and refrain from specified others to facilitate the ability of The Coca-Cola Company to receive favorable tax treatment in connection with its participation in the acquisition. In connection with the execution of the acquisition agreement for Panamco, The Coca-Cola Company and FEMSA memorialized their understandings relating to specified operational and business issues that may affect us following completion of the acquisition. A summary of these understandings is set forth under “—Major Shareholders—The Coca-Cola Memorandum.”
Associated Companies
We regularly engage in transactions with companies in which we own an equity interest. In Mexico, we purchase cans from IEQSA, in which we hold an approximate 33.68% interest, which in turn purchases cans from FEMSA Empaques. During 2003, we paid Ps.253.3 million to IEQSA. We also purchase sugar from Beta San Miguel, a sugar-cane producer in which we hold a 2.54% equity interest to which we paid Ps.221.2 million in 2003. In 2003, Coca-Cola FEMSA de Buenos Aires purchased all of its can presentations from CICAN, a joint venture between Coca-Cola FEMSA de Buenos Aires and the Coca-Colabottlers in Argentina, Uruguay and Paraguay, in which Coca-Cola FEMSA de Buenos Aires owns a 48.1% interest. During 2003, we paid Ps.28.2 million to CICAN. In Colombia, we purchase some pre-formed ingots from Tapón Corona, in which we have a 40% equity interest and to which we paid Ps.43.8 million in 2003. In Brazil, we distribute beers manufactured by Cervejarias Kaiser, a subsidiary of Molson, in which we own a 0.74% equity interest and to which we paid Ps.24.2 million during 2003. We also buy a small quantity of raw materials from Distribuidora Plástica, S.A., Metalforma, S.A. and Vidrios Panameños, S.A. of which we own a 19.0%, 17.5% and 2.2% equity interest, respectively.
Other Related Party Transactions
José Antonio Fernández, Eva Garza de Fernández and Ricardo Guajardo Touché, who are directors of Coca-Cola FEMSA, are also members of the board of directors of ITESM, a Mexican private university that routinely receives donations from us.
In connection with the acquisition of Panamco, we hired Allen & Company LLC to provide advisory services. One of our directors, Enrique Senior, is a Managing Director of Allen & Company LLC and one of our alternate directors, Herbert Allen III, is the President of Allen & Company LLC. Allen & Company LLC provides investment banking services to us and our affiliates in the ordinary course of its business.
We are insured in Mexico primarily under FEMSA’s umbrella insurance policies with Grupo Nacional Provincial S.A., of which the son of the chairman of its board of directors is one of our alternate directors. The policies were purchased pursuant to a competitive bidding process. Fidelity bonds are purchased from Fianzas Monterrey New York Life S.A., of which one of our directors is the chairman of the board of review, and financial services are obtained from Grupo Financiero BBVA Bancomer, of which one of our directors, Ricardo Guajardo Touché is the chairman of the board of directors. Affiliates of Grupo Financiero BBVA Bancomer, purchased participations in the loans and certificados bursátiles incurred to finance the Panamco acquisition and acted as agent for the placement of the certificados bursátilesand periodically provide us with financing or financial advisory services in the ordinary course of their business. In each case, we believe the transactions were conducted on an arm’s length basis.
Item 8. Financial Information
Consolidated Financial Statements
See “Item 18. Financial Statements” and pages F-1 through F-41.
Dividend Policy
For a discussion of our dividend policy, see “Item 3. Key Information—Dividends and Dividend Policy.”
Significant Changes
No significant changes have occurred since the date of the annual financial statements included in this annual report.
Legal Proceedings
We are party to various legal proceedings in the ordinary course of business. Other than as disclosed in this annual report, we are not currently involved in any litigation or arbitration proceeding, including any proceeding that is pending or threatened of which we are aware, which we believe will have, or has had, a material adverse effect on our company. Other legal proceedings that are pending against or involve us and our subsidiaries are incidental to the conduct of our and their business. We believe that the ultimate disposition of such other proceedings individually or on an aggregate basis will not have a material adverse effect on our consolidated financial condition or results of operations.
Tax Matters. During 2002, we initiated an appeal related to the Impuesto Especial Sobre Productos y Servicios (Special Tax on Products and Services) or IEPS applicable to inventories produced with HFCS. Additionally, during 2003, we included in the appeal the IEPS applicable to carbonated soft drinks produced with non-sugar sweeteners. See “Item 4. Information on the Company—The Company—Regulation—Taxation of Soft Drinks.” On November 21, 2003, we obtained a favorable resolution for our 2002 claim and during 2004 expect to receive from the authorities the IEPS paid during 2002, including accrued interest. An appeal related to the IEPS paid in 2003 has also been initiated, and management and legal counsel believe that it is highly probable that it will obtain another favorable resolution.
Antitrust Matters. During May 2000, the Comisión Federal de Competencia in Mexico (the Mexican Antitrust Commission), pursuant to a complaint filed by PepsiCo and certain of its bottlers in Mexico, initiated an investigation of the sales practices of The Coca-Cola Company and its bottlers. In November 2000, in a preliminary decision and in February 2002, through a final resolution, the Mexican Antitrust Commission determined that The Coca-Cola Company and its bottlers engaged in monopolistic practices with respect to exclusivity arrangements with certain retailers. The Mexican Antitrust Commission did not impose any fines, but ordered The Coca-Cola Company and its bottlers, including certain Mexican subsidiaries of the company, to abstain from entering into any exclusivity arrangement with retailers. We, along with other Coca-Cola bottlers, appealed the resolution rendered in February 2002 by a Recurso de Revisión (Review Recourse), which was presented before the Mexican Antitrust Commission. The Mexican Antitrust Commission confirmed its original resolution and issued a confirmatory resolution in July 2002. We and our Mexican operating subsidiaries appealed this resolution before the competent courts by initiating several juicios de amparo (appeals based on the violation of constitutional rights) and obtained favorable decisions. Under these decisions, the resolution was declared null and void and the Mexican Antitrust Commission was ordered to issue a new resolution amending its determination that The Coca-Cola Company and its bottlers had engaged in monopolistic transactions.
In a different proceeding in 2003, we, The Coca-Cola Company and certain other Coca-Cola bottlers were requested by the Mexican Antitrust Commission to deliver certain proprietary information pursuant to a new
investigation initiated by the Mexican Antitrust Commission. We obtained injunctions against the orders from the Mexican Antitrust Commission to deliver the requested information.
Antitrust Matters in Costa Rica and Panama. During August 2001, the Comisión para Promover la Competencia in Costa Rica (Costa Rican Antitrust Commission) pursuant to a complaint filed by PepsiCo and its bottler in Costa Rica initiated an investigation of the sales practices of The Coca-Cola Company and our Costa Rica subsidiary for alleged monopolistic practices in the retail distribution channel, including sales gained through exclusivity arrangements. Although no assurances can be given, we do not believe that the outcome of this matter, even if determined against the company, will have a material adverse effect on our financial condition or results of operations. Our Costa Rica subsidiary has vigorously defended itself throughout the process and is anticipating a decision from the Costa Rican Antitrust Commission at any time.
During 2002, Refrescos Nacionales, S.A., the Pepsi bottler in Panama, initiated a lawsuit against our Panamanian operating subsidiary, based on alleged monopolistic practices in the retail distribution channel through the implementation of exclusivity agreements, which allegedly have caused significant financial and sales losses to the plaintiff. We believe this lawsuit is without merit and intend to vigorously defend ourselves in this matter.
Labor Matters. During July 2001, a labor union and several individuals from the Republic of Colombia filed a lawsuit in the U.S. District Court for the Southern District of Florida against certain of our subsidiaries. In the complaint, the plaintiffs alleged that the subsidiaries of the company acquired in the Panamco acquisition engaged in wrongful acts against the labor union and its members in Colombia, including kidnapping, torture, death threats and intimidation. The complaint alleges claims under the U.S. Alien Tort Claims Act, Torture Victim Protection Act, Racketeer Influenced and Corrupt Organizations Act and state tort law and seeks injunctive and declaratory relief and damages of more than U.S.$500 million, including treble and punitive damages and the cost of the suit, including attorney fees. We filed a motion to dismiss the complaint for lack of subject matter and personal jurisdiction. We expect a ruling on the motion to dismiss at any time. We believe this lawsuit is without merit and intend to vigorously defend ourselves in this matter.
Tax Matters. In 1999, our Venezuelan subsidiary received notice of certain tax claims asserted by the Venezuelan taxing authorities. Our subsidiary has taken the appropriate recourses against these claims at the administrative level as well as at the court level. These claims currently total approximately U.S.$23 million. The company has certain rights to indemnification from Venbottling Holding, Inc., a former shareholder of Panamco and The Coca-Cola Company for a substantial portion of such claims. Based on the analysis that we have completed in relation to these claims, as well as the defense strategy that we have developed, we do not believe that the ultimate disposition of these cases will have a material adverse effect on our financial condition or results of operations.
Labor and Distribution Matters.Since 1999, a group of independent distributors of our Venezuela subsidiary commenced a proceeding to incorporate a union of distributors. As a result, these distributors may, among other things, individually demand certain labor and severance rights against our subsidiary. Since the incorporation process began, we have vigorously opposed its formation through all available legal channels. In February 2000, our subsidiary presented a nullity recourse against the union incorporation solicitation, as well as an injunction request before the Venezuelan Supreme Court. On September 20, 2001, the Venezuelan Supreme Court rendered its opinion confirming the incorporation of the union, but withheld granting any specific labor rights to the members of the union other than the right to be unionized. In order to obtain specific labor rights, the union, or its members, will have to request and obtain from a court of law a determination that the members of such union are considered workers pursuant to Venezuelan labor laws, and thereafter claim against our Venezuela subsidiary the payment of such benefits and rights including retroactive payments. To our knowledge, neither the union nor any of its individual members have initiated any process with the objective of obtaining such a court decision, although certain members of the union have threatened such action.
Since 2001, (after two decisions rendered during 2000 and 2001 by the Venezuelan Supreme Court against affiliates of Empresas Polar, S. A., whereby the Supreme Court found in those individual cases that the relationship between the affiliates of Empresas Polar, S. A. and those specific distributors was a relationship of labor nature and not of commercial nature) our subsidiary has been the subject of numerous claims by former distributors (including former members of the distributors union) claiming alleged labor and severance rights owed to them at the time of the termination of their relationship with us. As of December 31, 2003, our subsidiary was the subject of several lawsuits filed by former distributors for a total amount of approximately U.S.$31 million. Notwithstanding the number of claims and the amounts involved most of these claims have been filed by former distributors that either have entered into release agreements with our subsidiary at the time of their termination, and therefore we believe have no rights for additional claims, or are claims that have been filed after the expiration of the statute of limitations. There are also lawsuits presented by people that have never had a distributor or employee relationship with us, which the company believes have no merit. Since the decisions rendered by the Supreme Court during 2000 and 2001 against the affiliates of Empresas Polar, S. A., the Supreme Court has, during 2002 and 2003, revised its criteria for determining a labor relationship vis-à-vis a commercial relationship. The company believes based on the new decisions rendered by the Supreme Court, as well as based on the individual analysis of each individual claim, that these claims are without merit and intends to vigorously defend itself against them.
Item 9. The Offer and Listing
TRADING MARKETS
Since 1993, our Series L Shares have traded on the Mexican Stock Exchange and in the form of ADSs on the New York Stock Exchange. The ADSs were issued pursuant to a deposit agreement with the Bank of New York as depositary, and each ADS represents ten Series L Shares. On December 31, 2003, approximately 92% of the publicly traded Series L Shares were held in the form of ADSs.
The following table sets forth, for the periods indicated, the reported high and low sales prices for the Series L Shares on the Mexican Stock Exchange and the reported high and low sales prices for the ADSs on the New York Stock Exchange. Prices have not been restated in constant currency units.
Full year
2000:
2001:
2002:
First quarter
Second quarter
Third quarter
Fourth quarter
2003:
September
October
November
December
2004:
January
February
March(1)
Since November 1, 1996, our 8.95% Notes due November 1, 2006 have been listed on the New York Stock Exchange. The following table sets forth, for the periods indicated, the reported high and low sales prices for the notes, as a percentage of principal amount, on the New York Stock Exchange:
It is not practicable for us to determine the portion of the notes beneficially owned by U.S. persons.
TRADING ON THE MEXICAN STOCK EXCHANGE
The Mexican Stock Exchange or the Bolsa Mexicana de Valores, S.A. de C.V., located in Mexico City, is the only stock exchange in Mexico. Founded in 1907, it is organized as a corporation whose shares are held by 30 brokerage firms that are exclusively authorized to trade on the Exchange. Trading on the Mexican Stock Exchange takes place principally through automated systems that are open between the hours of 8:30 a.m. and 3:00 p.m. Mexico City time, each business day. Trades in securities listed on the Mexican Stock Exchange can also be effected off the Exchange. The Mexican Stock Exchange operates a system of automatic suspension of trading in shares of a particular issuer as a means of controlling excessive price volatility, but under current regulations this system does not apply to securities such as the Series L Shares that are directly or indirectly (for example, through ADSs) quoted on a stock exchange outside Mexico.
Settlement is effected two business days after a share transaction on the Mexican Stock Exchange. Deferred settlement, even by mutual agreement, is not permitted without the approval of the CNBV. Most securities traded on the Mexican Stock Exchange, including our shares, are on deposit with the Institución para el Depósito de Valores, S.A. de C.V., which we refer to as Indeval, a privately owned securities depositary that acts as a clearinghouse for Mexican Stock Exchange transactions.
Item 10. Additional Information
BYLAWS
Set forth below is a brief summary of certain significant provisions of our bylaws and Mexican law. This description does not purport to be complete and is qualified by reference to our bylaws and Mexican law. For a description of the provisions of our bylaws relating to our board of directors, executive officers and statutory examiners, see “Item 6. Directors, Senior Management and Employees.”
Organization and Register
We were incorporated on October 31, 1991, as a sociedad anónima de capital variable ( Mexican variable stock corporation) in accordance with the Mexican Companies Law. We were registered in the Public Registry of Commerce of Mexico City on August 23, 1993 under mercantile number 176543.
Purposes
The purposes of our company include the following:
Voting Rights; Transfer Restrictions
Series A Shares and Series D Shares have full voting rights but are subject to transfer restrictions. Although no Series B Shares have been issued, our bylaws provide for the issuance of Series B Shares with full voting rights that are freely transferable. Series L Shares are freely transferable but have limited voting rights. None of our shares are exchangeable for shares of a different series. The rights of all series of our capital stock are substantially identical except for:
Under our bylaws, holders of Series L Shares are entitled to vote only in limited circumstances. They may elect up to three of our eighteen directors and, in certain circumstances where holders of Series L Shares have not voted for the director elected by holders of the majority of these series of shares, they may be entitled to elect one or more additional directors. See “Item 6. Directors, Senior Management and Employees.” In addition, a quorum of 82% of our capital stock (including the Series L Shares) and the vote of at least a majority of our capital stock voting (and not abstaining) is required for:
The affirmative vote of 95% of our capital stock (including the Series L Shares) and the approval of the CNBV is required to amend the provisions of our bylaws that require our controlling shareholders, in the event of cancellation of the registration of any of our shares in the RNV, to make a public offer to acquire these shares. Holders of Series L Shares are not entitled to attend or to address meetings of shareholders at which they are not entitled to vote.
Under Mexican law, holders of shares of any series are also entitled to vote as a class on any action that would prejudice the rights of holders of shares of these series but not rights of holders of shares of other series. In addition, a holder of shares of the series that might be prejudiced would be entitled to judicial relief against any prejudicial action taken without the required vote. The determination of whether an action requires a class vote on these grounds would initially be made by our board of directors or our statutory examiners. A negative determination would be subject to judicial challenge by an affected shareholder, and the necessity for a class vote would ultimately be determined by a Mexican court. There are no other procedures for determining whether a particular proposed shareholder action requires a class vote, and Mexican law does not provide extensive guidance on the criteria to be applied in making such a determination.
In order to change any voting or quorum rights set out in the bylaws, the following is necessary: (i) a minimum quorum of holders of 95% of all the issued, subscribed and paid shares of Capital Stock, the vote of holders of at least 95% of all the issued, subscribed and paid shares of Capital Stock voting (and not abstaining) in connection therewith, and (ii) the previous approval of the CNBV.
Shareholders’ Meetings
Shareholders’ meetings may be ordinary meetings or extraordinary meetings. Extraordinary meetings are those called to consider certain matters specified in Article 182 of the Mexican Companies Law and the bylaws, including, principally, amendments to the bylaws, liquidation, dissolution, merger, transformation from one type of corporate form to another, change in nationality, change of corporate purpose, issuance of preferred stock and debentures, and increases and reductions of the fixed portion of the capital. In addition, our bylaws require an extraordinary meeting to consider the cancellation of the registration of our shares with the RNV or with other foreign stock exchanges on which its shares may be listed. All other matters are considered at an ordinary meeting.
Mexican law also provides for a special meeting of shareholders to allow holders of shares of a series to vote as a class on any action that would prejudice exclusively the rights of holders of such series.
An ordinary meeting of the holders of Series A and Series D Shares must be held at least once each year to consider the approval of the financial statements of our and certain of our subsidiaries for the preceding fiscal year and to determine the allocation of the profits of the preceding year. Holders of the Series A, Series D and Series L Shares at their respective special meetings must appoint, remove or ratify directors and statutory examiners, as well as determine their compensation.
Resolutions adopted at a extraordinary or ordinary shareholders meeting, are valid when adopted by holders of at least a majority of the issued, subscribed capital stock voting (and not abstaining) at the meeting, while resolutions adopted at a special shareholders meetings will be valid when adopted by the holders of at least a majority of the issued, subscribed and paid shares of the series of shares entitled to attend the special meeting.
The quorum for special meetings of any series of shares is a majority of the holders of the issued, subscribed, capital stock of such shares, and action may be taken by holders of a majority of such shares. The quorum for ordinary and extraordinary meetings at which holders of Series L Shares are not entitled to vote is 76% of the holders of our Series A and Series D Shares, and the quorum for an extraordinary meeting at which holders of Series L Shares are entitled to vote is 82% of the issued, subscribed and paid capital stock.
The board of directors, our Mexican statutory examiners, or, under certain circumstances, a Mexican court, may call shareholders’ meetings. Holders of 10% or more of our capital stock may require the board of directors or the statutory examiners to call a shareholders meeting at which the holders of Series L Shares would be entitled to vote, and holders of 10% or more of the Series A and Series D Shares may require the board of directors or the statutory examiners to call a meeting at which the holders of Series L Shares would not be entitled to vote. Notice of meetings and the meeting agendas must be published in a newspaper of general circulation in Mexico City at least 15 days prior to the meeting. In order to attend a meeting, shareholders must deposit their shares and receive a certificate from our corporate secretary (or, in the case of Series A or Series D Shares, from our transfer agent) authorizing participation in the meeting at least 48 hours in advance of the time set thereof or, in the case of Series L Shares held in book-entry form through Indeval, submit certificates evidencing a deposit of the shares with Indeval. If so entitled to attend the meeting, a shareholder may be represented by proxy. Our directors and statutory examiners may not act as proxies.
Under Mexican law, holders of 20% of our outstanding shares of common stock entitled to vote on a particular item may judicially oppose resolutions adopted at a shareholders’ meeting if the following conditions are met:
Transfer Restrictions
Our bylaws provide that no holder of Series A or Series D Shares may sell its shares unless it has disclosed the terms of the proposed sale and the name of the proposed buyer and has previously offered to sell the shares to the holders of the other series for the same price and terms as it intended to sell the shares to a third party. If the shareholders being offered shares do not choose to purchase the shares within 90 days of the offer, the selling shareholder is free to sell the shares to the third party at the price and under the specified terms. In addition, our bylaws impose certain procedures in connection with the pledge of any Series A or Series D Shares to any financial institution that are designed, among other things, to ensure that the pledged shares will be offered to the holders of the other Series at market value prior to any foreclosure. Finally, a proposed transfer of Series A or Series D Shares other than a proposed sale or a pledge, or a change of control of a holder of Series A or Series D Shares that is a subsidiary of a principal shareholder, would trigger
rights of first refusal to purchase the shares at market value. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders—The Shareholders Agreement.”
Dividend Rights
At the annual ordinary meeting of holders of Series A and Series D Shares, the board of directors submits our financial statements for the previous fiscal year, together with a report thereon by the board. The holders of Series A and Series D Shares, once they have approved the financial statements, determine the allocation of our net profits for the preceding year. They are required by law to allocate at least 5% of the net profits to a legal reserve, which is not thereafter available for distribution except as a stock dividend, until the amount of the legal reserve equals 20% of our historical capital stock (before the effect of restatement). Thereafter, the shareholders may determine and allocate a certain percentage of net profits to any special reserve, including a reserve for open-market purchases of our shares. The remainder of net profits are available for distribution. All shares outstanding and fully paid (including Series L Shares) at the time a dividend or other distribution is declared are entitled to share equally in the dividend or other distribution. No series of shares is entitled to a preferred dividend. Shares that are only partially paid participate in a dividend or other distributions in the same proportion that the shares have been paid at the time of the dividend or other distributions. Treasury shares are not entitled to dividends or other distributions. After ten years, dividend entitlement lapses in favor of the company.
Liquidation
Upon our liquidation, a liquidator may be appointed to wind up our affairs. All fully paid and outstanding shares of capital stock (including Series L Shares) will be entitled to participate equally in any distribution upon liquidation. Shares that are only partially paid participate in any distribution upon liquidation in the proportion that they have been paid at the time of liquidation. There are no liquidation preferences for any series of our shares.
Preemptive Rights
In the event of a capital increase, a holder of existing shares of the series to be issued has a preferential right to subscribe for a sufficient number of shares of the same series to maintain the holder’s existing proportionate holdings of shares. Preemptive rights must be exercised within a term of not less than 15 days following the publication of notice of the capital increase in the Diario Oficial de la Federación and in one of the newspapers of general circulation in our corporate domicile. Under Mexican law, preemptive rights cannot be waived in advance of the issuance thereof and cannot be represented by an instrument that is negotiable separately from the corresponding share. As a result, there is no trading market for the rights in connection with a capital increase. Holders of ADSs that are U.S. persons or located in the United States may be restricted in their ability to participate in the exercise of the preemptive rights. See “Risk Factors—Risks Related to the Series L Shares and the ADSs” for a description of the circumstances under which holders of ADSs may not be entitled to exercise preemptive rights.
Foreign Investment Legislation; Related Bylaw Provisions
Ownership by non-Mexicans of shares of Mexican enterprises is regulated by Ley de Inversión Extranjera (the 1993 Foreign Investment Law) and the subsequent 1998 regulations, the Foreign Investment Regulations. Comisión Nacional de Inversión Extranjera (the National Foreign Investment Commission) is responsible for the administration of the Foreign Investment Law. In order to comply with restrictions on the percentage of their capital stock that may be owned by non-Mexican investors, Mexican companies typically limit particular classes of their stock to Mexican ownership. Under the Foreign Investment Law, a trust for the benefit of one or more non-Mexican investors may qualify as Mexican if the trust meets certain conditions that will generally ensure that the non-Mexican investors do not determine how the shares are voted.
The Foreign Investment Law generally allows foreign holdings of up to 100% of the capital stock of Mexican companies. However, the law reserves certain economic activities exclusively for the Mexican state and certain other activities for Mexican individuals or Mexican corporations, the charters of which contain a prohibition on ownership by non-Mexicans of the corporation’s capital stock. Although the Foreign Investment Law grants broad authority to the
Foreign Investment Commission to allow foreign investors to own more than 49% of the capital of Mexican enterprises after taking into consideration public policy and economic concerns, our bylaws provide that Series A Shares shall at all times constitute no less than 51% of all outstanding common shares (excluding Series L Shares) and may only be held by Mexican investors.
Under our bylaws, in the event Series A Shares are subscribed or acquired by any other shareholders holding shares of any other series, and the shareholder has a nationality other than Mexican, these Series A Shares are automatically converted into shares of the same series of stock that this shareholder owns, and this conversion will be considered perfected at the same time as the subscription or acquisition, provided however that Series A Shares may never represent less than 51% of the outstanding capital stock.
Other Provisions
Redemption. Our fully paid shares are subject to redemption in connection with either (i) a reduction of capital stock or (ii) a redemption with retained earnings, which, in either case, must be approved by our shareholders at an extraordinary shareholders’ meeting. The shares subject to any such redemption would be selected by us by lot or in the case of redemption with retained earnings, by purchasing shares by means of a tender offer conducted on the Mexican Stock Exchange, in accordance with the Mexican Companies Law.
Capital Variations. According to our bylaws, any change in our authorized capital stock requires a resolution of an extraordinary meeting of shareholders. We are permitted to issue shares constituting fixed capital and shares constituting variable capital. At present, all of the issued shares of our capital stock, including those Series B and Series L Shares that remain in our treasury, constitute fixed capital. The fixed portion of our capital stock may only be increased or decreased by amendment of our bylaws upon resolution of an extraordinary meeting of the shareholders. The variable portion of our capital stock may be increased or decreased by resolution of an ordinary meeting of the shareholders without amending the bylaws. Under Mexican law and our bylaws, the outstanding variable portion of our stock may be redeemed at the holder’s option at any time at a redemption price equal to the lower of:
If this option is exercised during the first three quarters of a fiscal year, it is effective at the end of that fiscal year, but if it is exercised during the fourth quarter, it is effective at the end of the next succeeding fiscal year. The redemption price would be payable following the ordinary meeting at which the relevant annual financial statements are approved.
Fixed capital cannot be redeemed. Requests for redemption are satisfied only to the extent of available variable capital and in the order in which the requests are received. Requests that are received simultaneously are satisfied pro rata to the extent of available capital.
Forfeiture of Shares. As required by Mexican law, our bylaws provide that our non-Mexican shareholders formally agree with the Secretaría de Relaciones Exteriores (the Ministry of Foreign Affairs) to:
Failure to comply with these provisions is subject to a penalty of forfeiture of the shareholders’ capital interests in favor of Mexico. Under this provision, a non-Mexican shareholder is deemed to have agreed not to invoke the protection of his own government by asking its government to interpose a diplomatic claim against the Mexican government with respect to the shareholder’s rights as a shareholder. In the opinion of Lic. Carlos Aldrete Ancira, our
General Counsel, under this provision a non-Mexican shareholder is not deemed to have waived any other rights it may have, including any rights under the United States securities laws, with respect to its investment in our company. If the shareholder should invoke governmental protection in violation of this agreement, its shares could be forfeited to the Mexican government. Mexican law requires that this provision be included in the bylaws of all Mexican corporations unless the bylaws prohibit ownership of shares by non-Mexican persons.
Duration. Our existence under the bylaws continues until 2090 unless extended through a resolution of an extraordinary shareholders meeting.
Purchase of Our Own Shares. According to our bylaws, we generally may not repurchase our shares, subject to certain exceptions. First, we may repurchase fully paid shares for cancellation with distributable earnings pursuant to a decision of an extraordinary meeting of shareholders. Second, pursuant to judicial adjudication, we may acquire the shares of a shareholder in satisfaction of a debt owed to us by that shareholder; we must sell any shares so acquired within three months, otherwise our capital stock will be reduced and the shares cancelled. Third, in accordance with our bylaws, we would also be permitted to repurchase our own shares on the Mexican Stock Exchange under certain circumstances, with funds from a special reserve created for that purpose. We may hold shares we repurchase as treasury shares, which would be treated as authorized and issued but not outstanding unless and until subsequently subscribed for and sold.
Conflict of Interest. A shareholder or director voting on a business transaction in which its interests conflict with our interests may be liable for damages, but only if the transaction would not have been approved without the shareholder’s or director’s vote.
Actions Against Directors. Action for civil liabilities against directors may be initiated by resolution passed at an ordinary shareholders’ meeting. In the event the shareholders decide to bring the action, the directors against whom the action is brought immediately cease to be directors. Additionally, shareholders (including holders of Series L Shares) representing, in the aggregate, not less than 15% of the outstanding shares may directly bring an action against directors, provided that (i) the shareholders did not concur in the decision at the shareholders’ meeting not to take action against the directors and (ii) the claim covers all the damages alleged to have been caused to us and not only the portion corresponding to the shareholders. Any recovery of damages with respect to the action will be for our benefit and not for the shareholders bringing action.
Appraisal Rights. Whenever the shareholders approve a change of corporate purposes, change of nationality of the company or transformation from one form of company to another, any shareholder entitled to vote who has voted against the change may withdraw from our company and receive the amount attributable to its shares under Mexican law, provided that the shareholder exercises its rights within 15 days following the adjournment of the meeting at which the change was approved. In this case, the shareholder would be entitled to the reimbursement of its shares, in proportion to the company’s assets in accordance with the last approved balance sheet. Because holders of Series L Shares are not entitled to vote on certain types of these changes, these withdrawal rights are available to holders of Series L Shares in fewer cases than to holders of other series of our capital stock.
Rights of Shareholders
The protections afforded to minority shareholders under Mexican law are different from those in the United States and many other jurisdictions. The substantive law concerning fiduciary duties of directors has not been the subject of extensive judicial interpretation in Mexico, unlike many states in the United States where duties of care and loyalty elaborated by judicial decisions help to shape the rights of minority shareholders. Mexican civil procedure does not contemplate class actions or shareholder derivative actions, which permit shareholders in U.S. courts to bring actions on behalf of other shareholders or to enforce rights of the corporation itself. Shareholders cannot challenge corporate action taken at a shareholders’ meeting unless they meet certain procedural requirements, as described above under “—Shareholders’ Meetings.”
As a result of these factors, in practice it may be more difficult for our minority shareholders to enforce rights against us or our directors or controlling shareholders than it would be for shareholders of a United States company.
In addition, under the United States federal securities laws, as a foreign private issuer, we are exempt from certain rules that apply to domestic United States. issuers with equity securities registered under the United States. Securities Exchange Act of 1934, including the proxy solicitation rules, the rules requiring disclosure of share ownership by directors, officers and certain shareholders. We are also exempt from certain of the corporate governance requirements of the New York Stock Exchange, Inc., including the requirements concerning independent directors.
Enforceability of Civil Liabilities
We are organized under the laws of Mexico, and most of our directors, officers, and controlling persons reside outside the United States. In addition, a substantial portion of our assets and their assets are located in Mexico. As a result, it may be difficult for investors to effect service of process within the United States on such persons. It may also be difficult to enforce against them, either inside or outside the United States, judgments obtained against them in United States courts, or to enforce in United States courts judgments obtained against them in courts in jurisdictions outside the United States, in any action based on civil liabilities under the United States federal securities laws. There is doubt as to the enforceability against these persons in Mexico, whether in original actions or in actions to enforce judgments of United States courts, of liabilities based solely on the United States federal securities laws.
MATERIAL AGREEMENTS
We manufacture, package, distribute and sell soft drink beverages and bottled water under bottler agreements with The Coca-Cola Company. In addition, pursuant to a tradename licensing agreement with The Coca-Cola Company, we are authorized to use certain trademark names of The Coca-Cola Company. For a discussion of the terms of these agreements, see “Item 4. Information on the Company—Bottler Agreements.”
We are managed as a joint venture between a subsidiary of FEMSA and certain subsidiaries of The Coca-Cola Company, pursuant to a shareholders agreement. For a discussion of the terms of this agreement, see “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders—The Shareholders Agreement.”
We purchase the majority of our non-returnable plastic bottles, as well as pre-formed plastic ingots for the production of non-returnable plastic bottles, from ALPLA, an authorized provider of PET for The Coca-Cola Company, pursuant to an agreement we entered into in April 1998 for our original operations in Mexico. Under this agreement, we rent plant space to ALPLA, where it produces PET bottles and ingots to certain specifications and quantities for our use.
See “Item 5. Operating and Financial Review and Prospects—Summary of Significant Debt Obligations” for a brief discussion of certain terms of our significant debt agreements.
See “Item 7. Major Shareholders and Related Party Transactions—Related Party Transactions” for a discussion of other transactions and agreements with our affiliates and associated companies.
EXCHANGE CONTROLS
The Mexican economy has suffered balance of payment deficits and shortages in foreign exchange reserves. While the Mexican government does not currently restrict the ability of Mexican or foreign persons or entities to convert Mexican pesos to U.S. dollars, no assurance can be given that the Mexican government will not institute a restrictive exchange control policy in the future.
TAXATION
The following summary contains a description of certain U.S. federal income and Mexican federal tax consequences of the purchase, ownership and disposition of our 8.95% Notes due November 1, 2006, which we refer to as the Notes, Series L Shares or ADSs by a holder that is a citizen or resident of the United States, a U.S. domestic corporation or a person or entity that otherwise will be subject to U.S. federal income tax on a net income basis in respect of the Notes, Series L Shares or ADSs, which we refer to as a U.S. holder, but it does not purport to be a description of all of the possible tax considerations that may be relevant to a decision to purchase the Notes, Series L Shares or ADSs. In particular, this discussion does not address all Mexican or U.S. federal income tax considerations that may be relevant to a particular investor, nor does it address the special tax rules applicable to certain categories of investors, such as banks, dealers, traders who elect to mark to market, tax-exempt entities, insurance companies, investors who hold the Notes, Series L Shares or ADSs as part of a hedge, straddle, conversion or integrated transaction or investors who have a “functional currency” other than the U.S. dollar. This summary deals only with U.S. holders that will hold the Notes, Series L Shares or ADSs as capital assets, but does not address the tax treatment of a U.S. holder that owns or is treated as owning 10% or more of the voting shares (including Series L Shares) of our company. Nor does it address the situation of holders of Notes who did not acquire the Notes as part of the initial distribution.
This summary is based upon tax laws of the United States and Mexico as in effect on the date of this annual report, including the provisions of the income tax treaty between the United States and Mexico, which we refer in this annual report as the Tax Treaty, which are subject to change. The summary does not address any tax consequences under the laws of any state or locality of Mexico or the United States or the laws of any taxing jurisdiction other than the federal laws of Mexico and the United States. Holders of the Notes, Series L Shares or ADSs should consult their tax advisers as to the U.S., Mexican or other tax consequences of the purchase, ownership and disposition of Notes, Series L Shares or ADSs, including, in particular, the effect of any foreign, state or local tax laws.
Mexican Taxation
For purposes of this summary, the term “non-resident holder” means a holder that is not a resident of Mexico and that does not hold the Notes, Series L Shares, or ADSs in connection with the conduct of a trade or business through a permanent establishment in Mexico. For purposes of Mexican taxation, an individual is a resident of Mexico if he or she has established his or her home in Mexico, or if he or she has another home outside Mexico but his or her “center of vital interest” (as defined in the Mexican Tax Code) is located in Mexico. It is considered that the “center of vital interests” of an individual is situated in Mexico, among other cases, when more than 50% of that person’s total income during a calendar year originates from within Mexico. A legal entity is a resident of Mexico either if it is organized under the laws of Mexico or if it has its principal place of business or its place of effective management in Mexico. A Mexican citizen is presumed to be a resident of Mexico unless such a person can demonstrate that the contrary is true. If a legal entity or an individual is deemed to have a permanent establishment in Mexico for tax purposes, all income attributable to such a permanent establishment will be subject to Mexican taxes, in accordance with applicable tax laws.
Tax Considerations Relating to the Notes
Taxation of Interest and Principal in Respect of the Notes. Under Mexican income tax law, payments of interest by a Mexican issuer in respect of its notes (including payments of principal in excess of the issue price of such notes, which, under Mexican law, are deemed to be interest) to a non-resident holder will generally be subject to a Mexican withholding tax assessed at a rate of 4.9% if (i) the relevant notes are registered with the Special Section of the National Registry of Securities and Intermediaries maintained by the National Banking and Securities Commission, (ii) the notes are placed, through banks or brokerage houses, in a country that has entered into a treaty to avoid double taxation with Mexico, and (iii) no party related to us (defined under the applicable law as parties that are shareholders of our company that own, directly or indirectly, individually or collectively, with related persons (within the meaning of the applicable law) more than ten percent of our voting stock or corporations more than twenty percent of the stock of which is owned, directly or indirectly, individually or collectively, by related persons of our company), directly or indirectly, is the effective beneficiary of five percent or more of the aggregate amount of each such interest payment.
Apart from the Mexican income tax law discussed in the preceding paragraph, other provisions reducing the rate of Mexican withholding taxes may also apply. Under the Tax Treaty, the rate would be 4.9% for certain holders that are residents of the United States (within the meaning of the Tax Treaty). If the requirements described in the preceding paragraph are not met and no other provision reducing the rate of Mexican withholding taxes applies, such interest payments will be subject to a Mexican withholding tax assessed at a rate of 10%.
Payments of interest made by us with respect to the Notes to non-Mexican pension or retirement funds will be exempt from Mexican withholding taxes, provided that any such fund (i) is duly incorporated pursuant to the laws of its country of origin and is the effective beneficiary of the interest accrued, (ii) is exempt from income tax in such country, and (iii) is registered with the Ministry of Finance for that purpose.
We have agreed, subject to specified exceptions, to pay additional amounts, which we refer to as Additional Amounts, to the holders of the Notes in respect of the Mexican withholding taxes mentioned above. If we pay Additional Amounts in respect of such Mexican withholding taxes, any refunds received with respect to such Additional Amounts will be for the account of our company.
Holders or beneficial owners of Notes may be requested by us to provide certain information or documentation required by applicable law to facilitate the determination of the appropriate withholding tax rate applicable to such holders or beneficial owners. In the event that the specified information or documentation concerning the holder or beneficial owner, if requested, is not provided on a timely basis, our obligation to pay Additional Amounts may be limited.
Under existing Mexican law and regulations, a non-resident holder will not be subject to any Mexican taxes in respect of payments of principal made by us with respect to the Notes.
Taxation of Dispositions of Notes. Capital gains resulting from the sale or other disposition of the Notes by a non-resident holder will not be subject to Mexican income or other taxes.
Tax Considerations Relating to the Series L Shares and the ADSs
Taxation of Dividends. Under Mexican income tax law, dividends, either in cash or in kind, paid with respect to the Series L Shares represented by ADSs or the Series L Shares are not subject to Mexican withholding tax.
Taxation of Dispositions of ADSs or Series L Shares.Gains from the sale or disposition of ADSs by non-resident holders will not be subject to Mexican withholding tax. Gains from the sale of Series L Shares carried out by non-resident holders through the Mexican Stock Exchange or other securities markets situated in countries that have a tax treaty with Mexico will generally be exempt from Mexican tax provided certain additional requirements are met. Also, certain restrictions will apply if the Series L Shares are transferred as a consequence of public offerings.
Gains on the sale or other disposition of Series L Shares or ADSs made in other circumstances generally would be subject to Mexican tax, regardless of the nationality or residence of the transferor. However, under the Tax Treaty, a holder that is eligible to claim the benefits of the Tax Treaty will be exempt from Mexican tax on gains realized on a sale or other disposition of Series L Shares or ADSs in a transaction that is not carried out through the Mexican Stock Exchange or other approved securities markets, so long as the holder did not own, directly or indirectly, 25% or more of our total capital stock (including Series L Shares represented by ADSs) within the 12-month period preceding such sale or other disposition. Deposits of Series L Shares in exchange for ADSs and withdrawals of Series L Shares in exchange for ADSs will not give rise to Mexican tax.
Non-resident holders that do not meet the requirements referred to above are subject to a 5% withholding tax on the gross sales price received upon the sale of Series L Shares through the Mexican Stock Exchange. Alternatively, non-resident holders may elect to be subject to a 20% tax rate on their net gains from the sale as calculated pursuant to the Mexican Income Tax Law provisions. In both cases, the financial institutions involved in the transfers must withhold the tax.
Other Mexican Taxes
There are no Mexican inheritance, gift, succession or value added taxes applicable to the ownership, transfer, exchange or disposition of the Notes, ADSs or the Series L Shares, although gratuitous transfers of Series L Shares may in certain circumstances cause a Mexican federal tax to be imposed upon the recipient. There are no Mexican stamp, issue, registration or similar taxes or duties payable by holders of the Notes, ADSs or Series L Shares.
United States Taxation
Taxation of Interest and Additional Amounts in Respect of the Notes. A U.S. holder will treat the gross amount of interest and Additional Amounts (i.e., without reduction for Mexican withholding taxes) as ordinary interest income in respect of the Notes. Mexican withholding taxes paid at the appropriate rate applicable to the U.S. holder will be treated as foreign income taxes eligible for credit against such U.S. holder’s United States federal income tax liability, subject to generally applicable limitations and conditions, or, at the election of such U.S. holder, for deduction in computing such U.S. holder’s taxable income. Interest and Additional Amounts constitute income from sources without the United States for foreign tax credit purposes. During any period where the applicable withholding rate is 4.9%, such income generally will constitute “passive income” or, in the case of certain U.S. holders, “financial services income.” If the Mexican withholding tax rate applicable to a U.S. holder is 5% or more, however, such income generally will constitute “high withholding tax interest.”
The calculation of foreign tax credits and, in the case of a U.S. holder that elects to deduct foreign taxes, the availability of deductions, involves the application of rules that depend on a U.S. holder’s particular circumstances. U.S. holders should consult their own tax advisers regarding the availability of foreign tax credits and the treatment of Additional Amounts.
Foreign tax credits may not be allowed for withholding taxes imposed in respect of certain short-term or hedged positions in securities or in respect of arrangements in which a U.S. holder’s expected economic profit is insubstantial. U.S. holders should consult their own advisers concerning the implications of these rules in light of their particular circumstances.
A holder or beneficial owner of Notes that is, with respect to the United States, a foreign corporation or a nonresident alien individual, which we refer to as a Non-U.S. holder, generally will not be subject to U.S. federal income or withholding tax on interest income or Additional Amounts earned in respect of Notes, unless such income is effectively connected with the conduct by the Non-U.S. holder of a trade or business in the United States.
Taxation of Dispositions of Notes. A gain or loss realized by a U.S. holder on the sale, exchange, redemption or other disposition of Notes generally will be a long-term capital gain or loss if, at the time of the disposition, the Notes have been held for more than one year. Long-term capital gain recognized by a U.S. holder that is an individual is subject to lower rates of federal income taxation than ordinary income or short-term capital gain. The deduction of capital loss is subject to limitations for U.S. federal income tax purposes.
In general, for U.S. federal income tax purposes, holders of ADSs will be treated as the owners of the Series L Shares represented by those ADSs.
Taxation of Dividends.The gross amount of any dividends paid with respect to the Series L Shares represented by ADSs or the Series L Shares generally will be included in the gross income of a U.S. holder as ordinary income on the day on which the dividends are received by the U.S. holder, in the case of the Series L Shares, or by the Depositary, in the case of the Series L Shares represented by ADSs, and will not be eligible for the dividends received deduction allowed to corporations under the Internal Revenue Code of 1986, as amended. Dividends, which will be paid in Mexican pesos, will be includible in the income of a U.S. holder in a U.S. dollar amount calculated, in general, by
reference to the exchange rate in effect on the date that they are received by the U.S. holder, in the case of the Series L Shares, or by the Depositary, in the case of the Series L Shares represented by the ADSs (regardless of whether such Mexican pesos are in fact converted into U.S. dollars on such date). If such dividends are converted into U.S. dollars on the date of receipt, a U.S. holder generally should not be required to recognize foreign currency gain or loss in respect of the dividends. Subject to certain exceptions for short-term and hedged positions, the U.S. dollar amount of dividends received by an individual U.S. holder in respect of Series L Shares or ADSs after December 31, 2002 and before January 1, 2009 is subject to taxation at a maximum rate of 15%. U.S. holders should consult their own tax advisers regarding the availability of the reduced dividends tax rate in light of their own particular circumstances. U.S. holders should consult their tax advisers regarding the treatment of the foreign currency gain or loss, if any, on any Mexican pesos received that are converted into U.S. dollars on a date subsequent to the date of receipt. Dividends generally will constitute foreign source “passive income” or, in the case of certain U.S. holders, “financial services income” for U.S. foreign tax credit purposes.
Distributions to holders of additional Series L Shares with respect to their ADSs that are made as part of a pro rata distribution to all of our shareholders generally will not be subject to U.S. federal income tax.
A holder of Series L Shares or ADSs that is, with respect to the United States, a foreign corporation or Non-U.S. holder generally will not be subject to U.S. federal income or withholding tax on dividends received on Series L Shares or ADSs, unless such income is effectively connected with the conduct by the Non-U.S. holder of a trade or business in the United States.
Taxation of Capital Gains. A gain or loss realized by a U.S. holder on the sale or other disposition of ADSs or Series L Shares will be subject to U.S. federal income taxation as capital gain or loss in an amount equal to the difference between the amount realized on the disposition and such U.S. holder’s tax basis in the ADSs or the Series L Shares. Any such gain or loss will be a long-term capital gain or loss if the ADSs or Series L Shares were held for more than one year on the date of such sale. Long-term capital gain recognized by a U.S. holder that is an individual is subject to lower rates of federal income taxation than ordinary income or short-term capital gain. The deduction of capital loss is subject to limitations for U.S. federal income tax purposes. Deposits and withdrawals of Series L Shares by U.S. holders in exchange for ADSs will not result in the realization of gain or loss for U.S. federal income tax purposes.
Gain, if any, realized by a U.S. holder on the sale or other disposition of Series L Shares or ADSs will be treated as U.S. source income for U.S. foreign tax credit purposes. Consequently, if a Mexican withholding tax is imposed on the sale or disposition of Series L Shares, a U.S. holder that does not receive significant foreign source income from other sources may not be able to derive effective U.S. foreign tax credit benefits in respect of these Mexican taxes. U.S. holders should consult their own tax advisers regarding the application of the foreign tax credit rules to their investment in, and disposition of, Series L Shares.
A Non-U.S. holder of Series L Shares or ADSs will not be subject to U.S. federal income or withholding tax on any gain realized on the sale of Series L Shares or ADSs, unless (i) such gain is effectively connected with the conduct by the Non-U.S. holder of a trade or business in the United States, or (ii) in the case of gain realized by an individual Non-U.S. holder, the Non-U.S. holder is present in the United States for 183 days or more in the taxable year of the sale and certain other conditions are met.
United States Backup Withholding and Information Reporting
A U.S. holder of Series L Shares, ADSs or notes may, under certain circumstances, be subject to “backup withholding” with respect to certain payments to such U.S. holder, such as dividends, interest or the proceeds of a sale or disposition of Series L Shares, ADSs or Notes, unless such holder (i) is a corporation or comes within certain exempt categories, and demonstrates this fact when so required, or (ii) provides a correct taxpayer identification number, certifies that it is not subject to backup withholding and otherwise complies with applicable requirements of the backup withholding rules. Any amount withheld under these rules does not constitute a separate tax and will be creditable against the holder’s U.S. federal income tax liability. While Non-U.S. holders generally are exempt from backup withholding, a Non-U.S. holder may, in certain circumstances, be required to comply with certain information and identification procedures in order to prove this exemption.
DOCUMENTS ON DISPLAY
We file reports, including annual reports on Form 20-F, and other information with the SEC pursuant to the rules and regulations of the SEC that apply to foreign private issuers. You may read and copy any materials filed with the SEC at its public reference rooms in Washington, D.C., at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. As a foreign private issuer, we were not required to make filings with the SEC by electronic means prior to November 4, 2002. Any filings we make electronically will be available to the public over the Internet at the SEC’s web site at http://www.sec.gov.
Item 11. Quantitative and Qualitative Disclosures about Market Risk
Our business activities require the holding or issuing of financial instruments that expose us to market risks related to changes in interest rates, foreign currency exchange rates, equity risk and commodity price risk.
Interest Rate Risk
Interest rate risk exists principally with respect to our indebtedness that bears interest at floating rates. At December 31, 2003, we had outstanding indebtedness of Ps.27,256.8 million, of which 35.7% bore interest at fixed interest rates and 64.3% bore interest at variable interest rates. Swap contracts held by us effectively switch a portion of our variable-rate indebtedness into fixed-rate indebtedness. After giving effect to these contracts, as of December 31, 2003 69.8% of our debt was fixed-rate and 30.2% of our debt was variable-rate. The interest rate on our variable rate debt is determined by reference to the London Interbank Offer Rate, or LIBOR, a benchmark rate used for Eurodollar loans, the CETE, U.S. treasury bonds and TIIE. If these reference rates increase, our interest payments would consequently increase.
The table below provides information about our financial instruments that are sensitive to changes in interest rates, including the effect of our interest rate swaps on our debt obligations. The table presents notional amounts and weighted average interest rates by expected contractual maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average variable rates are based on the reference rates on December 31, 2003, plus spreads, contracted by us. The instruments’ actual payments are denominated in U.S. dollars, Mexican pesos and Colombian pesos. All of the payments in the table are presented in Mexican pesos, our reporting currency, utilizing the December 31, 2003 exchange rate of Ps.11.235 Mexican pesos per U.S. dollar.
The table below also includes the fair value of long-term debt based on the discounted value of contractual cash flows. The discount rate is estimated using rates currently offered for debt with similar terms and remaining maturities. Furthermore, the fair value of long-term notes payable is based on quoted market prices, and the fair value of the interest rate swaps is estimated based on quoted market prices to terminate the contracts on December 31, 2003. As of December 31, 2003, the fair value represents a loss amount of Ps.712 million.
Principal by Year of MaturityAt December 31, 2003(millions of constant Mexican pesos)
In the table above we are including the effects of all of our interest swaps agreements, each of which is a contract that swaps a variable interest rate for a fixed interest rate. As of December 31, 2003, we have the following outstanding agreements:
A hypothetical, instantaneous and unfavorable change of 100 basis points in the average interest rate applicable to floating-rate liabilities held at December 31, 2003 would increase our interest expense by approximately Ps.82 million, or 16.0% over a 12-month period of 2004, assuming no additional debt is incurred during such period, in each case after giving effect to all of our interest swap agreements.
Foreign Currency Exchange Rate Risk
Our principal exchange rate risk involves changes in the value of the local currencies, of each country in which we operate, relative to the U.S. dollar. In 2003, the percentage of our consolidated total revenues was denominated as follows:
Total Revenues by Currency
At December 31, 2003
Mexican peso (Mexico)
66.6
Quetzal (Guatemala)
1.4
Cordoba (Nicaragua)
1.3
Colon (Costa Rica)
2.2
U.S. dollar (Panama)
Colombian peso (Colombia)
6.5
Bolivar (Venezuela)
7.1
Real (Brazil)
7.8
Argentine peso (Argentina)
5.8
We estimate that a majority of our consolidated costs and expenses are denominated in Mexican pesos for Mexican subsidiaries and in the aforementioned currencies for the foreign subsidiaries that are part of Coca-Cola FEMSA. Substantially all of our costs and expenses denominated in a foreign currency, other than the functional currency of each country in which we operate, are denominated in U.S. dollars. As of December 31, 2003, 45.9% of our indebtedness was denominated in U.S. dollars, 51.9% in Mexican pesos and the remaining 2.2% in Colombian pesos. Decreases in the value of the different currencies relative to the U.S. dollar will increase the cost of our foreign currency denominated operating costs and expenses and of the debt service obligations with respect to our foreign currency denominated indebtedness. A depreciation of the Mexican peso relative to the U.S. dollar will also result in foreign exchange losses as the Mexican peso value of our foreign currency denominated indebtedness is increased.
Our exposure to market risk associated with changes in foreign currency exchange rates relates primarily to U.S. dollar-denominated debt obligations as shown in the interest risk table above. We occasionally utilize currency forward contracts to hedge our exposure to the U.S. dollar relative to the Mexican peso and other currencies.
As of December 31, 2003 and 2002, we did not have any forward agreements to hedge our operations denominated in U.S. dollars, and we did not have any call option agreements to buy U.S. dollars.
The fair value of the foreign currency forward contracts is estimated based on quoted market prices of each agreement at year-end assuming the same maturity dates originally contracted. The fair value of the call option agreements is estimated based on quoted market prices of the cost of such agreements, considering the same amounts, exchange rates and maturity dates originally contracted.
A hypothetical, instantaneous and unfavorable 10% devaluation in the value of the Mexican peso relative to the U.S. dollar occurring on December 31, 2003, would have resulted in an increase in our net consolidated integral result of financing expense of approximately Ps.1,239 million over a 12-month period of 2004, reflecting higher interest expense and foreign exchange gain generated by the cash balances held in U.S. dollars as of that date, net of the loss based on our U.S. dollar-denominated indebtedness at December 31, 2003. However, this result does not take into account any gain on monetary position that would be expected to result from an increase in the inflation rate generated by a devaluation of the Mexican peso relative to the U.S. dollar, which gain on monetary position would reduce the consolidated net integral result of financing.
As of March 15, 2004, the exchange rates relative to the U.S. dollar of all the countries in which we operate have had revaluation or devaluation movements as follows:
10.95
2.5%
8.10
(0.9)%
15.71
(1.0)%
422.47
(0.8)%
–
2,654.10
4.5%
1,920.00
(3.6)%
2.91
(0.7)%
0.9%
A hypothetical, instantaneous and unfavorable 10% devaluation in the value of the currencies, of all the countries in which we operate, on an individual basis, relative to the U.S. dollar occurring on December 31, 2003, would produce a reduction in stockholders’ equity of approximately the following amounts:
Equity Risk
During 2002, one of our subsidiaries entered into an equity forward purchase contract, expiring in June 2004, on 92% of the Molson shares received from the sale of Cervejarias Kaiser, with a notional amount of approximately Ps.203.4 million. The fair value of the equity forward purchase contract of Ps.73.8 million is the loss resulting from the difference between the strike price of the forward contract and the market value of the shares.
Commodity Price Risk
We entered into various derivative contracts to hedge the cost of certain raw materials. The result of the commodity price contracts was a gain of Ps.3 million as of December 31, 2003, which where recorded in the results of operations of the year. The fair value is estimated based on the quoted market prices to terminate the contracts at the reporting date. As of December 31, 2003, we had various derivate instruments contracts with maturity dates in 2004 and 2005, notional amounts of Ps.59 million and the fair value of Ps.3 million.
The outstanding agreements and their terms are as follows:
Year Ended December 31, 2003(thousands of Mexican pesos)
2004
Swaptions
Swaps
21,687
2,783
1,370
The fair value is estimated based on quoted market prices to terminate the agreements at December 31, 2003.
Items 12-14. Not Applicable
Item 15. Controls and Procedures
(a) As of December 31, 2003, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon and as of the date of our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported as and when required.
(b) There has been no change in our internal control over financial reporting during 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 16A. Audit Committee Financial Expert
At our annual ordinary shareholders’ meeting in March 2004, our shareholders elected the following four members of the Audit Committee: Alexis Rovzar, Charles H. McTier, José Manuel Canal and Francisco Zambrano and designated Mr. José Manuel Canal as an “audit committee financial expert” within the meaning of this Item 16A. Although under Mexican law the determination of the shareholders is binding on our company, our board of directors will confirm this designation at its next board meeting.
Item 16B. Code of Ethics
We have adopted a code of ethics, as defined in Item 16B of Form 20-F under the Securities Exchange Act of 1934, as amended. Our code of ethics applies to our Chief Executive Officer, Chief Financial Officer and persons performing similar functions as well as to our directors and other officers and employees. Our code of ethics is available on our web site at www.cocacola-femsa.com.mx/code of ethics. If we amend the provisions of our code of ethics that apply to our Chief Executive Officer, Chief Financial Officer and persons performing similar functions, or if we grant any waiver of such provisions, we will disclose such amendment or waiver on our web site at the same address
Item 16C. Principal Accountant Fees and Services
Audit and Non-Audit Fees
The following table summarizes the aggregate fees billed to us by Galaz, Yamazaki, Ruiz Urquiza, S.C., a member firm of Deloitte Touche Tohmatsu, and its affiliates including Deloitte Consulting, which we collectively refer to as Deloitte & Touche, during the fiscal years ended December 31, 2002 and 2003:
(millions of Mexican pesos)
Audit fees
50
Audit-related fees
6
Tax fees
3
Other fees
2
Total fees
61
Audit fees. Audit fees in the above table are the aggregate fees billed by Deloitte & Touche in connection with the audit of our annual financial statements, the review of our quarterly financial statements, and statutory and regulatory audits. Additionally, in 2003, the audit fees included the opening balance sheet audit fees associated with the Panamco acquisition.
Audit-related Fees. Audit-related fees in the above table for the year ended December 31, 2003 are the aggregate fees billed by Deloitte & Touche for financial accounting and reporting consultations.
Audit-related fees in the above table for the year ended December 31, 2002 are the aggregate fees billed by Deloitte & Touche for due diligence associated with acquisitions (predominately the Panamco acquisition), financial accounting and reporting consultations.
Tax Fees. Tax fees in the above table are fees billed by Deloitte & Touche for services based upon existing facts and prior transactions in order to document, compute, and obtain government approval for amounts included in tax filings such as value-added tax return assistance, transfer pricing documentation and requests for technical advice from taxing authorities.
Other Fees. Other fees in the above table are fees billed by Deloitte and Touche for non-audit services rendered by Deloitte Consulting. As a percentage of total fees billed to Coca-Cola FEMSA, other fees represent 3.3% and 5.7% for 2003 and 2002, respectively.
Audit Committee Pre-Approval Policies and Procedures
We have adopted pre-approval policies and procedures under which all audit and non-audit services provided by our external auditors must be pre-approved by the audit committee as set forth in the audit committee’s charter. Any service proposals submitted by external auditors need to be discussed and approved by the audit committee during its meetings, which take place at least four times a year. Once the proposed service is approved, we or our subsidiaries formalize the engagement of services. The approval of any audit and non-audit services to be provided by our external auditors is specified in the minutes of our audit committee. In addition, the members of our board of directors are briefed on matters discussed by the different committees of our board.
Item 16D. Not Applicable
Item 16E. Not Applicable
Item 17. Not Applicable
Item 18. Financial Statements
Reference is made to Item 19(a) for a list of all financial statements filed as part of this annual report.
Item 19. Exhibits
(a) List of Financial Statements
Page
Report of Independent Public Accountants
F-1
Consolidated Balance Sheets at December 31, 2003 and 2002
F-2
Consolidated Income Statements For the Years Ended December 31, 2003, 2002 and 2001
F-4
Consolidated Statements of Changes in Financial Position For the Years Ended December 31, 2003, 2002 and 2001
F-5
Consolidated Statements of Changes in Stockholders’ Equity For the Years Ended December 31, 2003, 2002 and 2001
F-6
Notes to the Consolidated Financial Statements*
F-8
(b) List of Exhibits
Omitted from the exhibits filed with this annual report are certain instruments and agreements with respect to long-term debt of Coca-Cola FEMSA, none of which authorizes securities in a total amount that exceeds 10% of the total assets of Coca-Cola FEMSA. We hereby agree to furnish to SEC copies of any such omitted instruments or agreements as the Commission requests.
SIGNATURE
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant certifies that it meets all the requirements for filing on Form 20-F and has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 5, 2004
By: /s/
HÉCTOR TREVIÑOGUTIÉRREZHéctor Treviño Gutiérrez
2001
$
3,158,596
Ps.
35,486,829
18,518,634
17,636,475
Other operating revenues
21,592
242,588
148,879
135,089
3,180,188
35,729,417
18,667,513
17,771,564
1,600,387
17,980,349
8,680,755
8,255,731
1,579,801
17,749,068
9,986,758
9,515,833
Operating expenses:
Administrative
207,735
2,333,900
1,474,810
1,357,739
Selling
774,793
8,704,808
3,844,503
3,993,292
982,528
11,038,708
5,319,313
5,351,031
Amortization of goodwill
40,635
108,253
597,273
6,710,360
4,626,810
4,056,549
Integral result of financing:
Interest expense
138,091
1,551,452
348,379
343,435
Interest income
(20,208
(227,039
)
(263,986
(287,692
Foreign exchange (gain) loss, net
180,500
2,027,922
(249,961
(10,330
(Gain) loss on monetary position
(77,512
(870,843
(394,776
84,183
220,871
2,481,492
(560,344
129,596
Other expense, net
21,238
238,586
614,240
44,147
Income for the year before income taxes, employee profit sharing and change in accounting principles
355,164
3,990,282
4,572,914
3,882,806
Income taxes and employee profit sharing
147,594
1,658,229
1,912,113
1,526,743
Income for the year before change in accounting principles
207,570
2,332,053
2,660,801
2,356,063
Change in accounting principles
30,124
Net income for the year
2,325,939
Minority net income
1,799
20,211
205,771
2,311,842
Weighted average shares outstanding (in thousands)
1,704,250
1,425,000
Income per share before change in accounting principles
1.65
Majority net income per share
RESOURCES GENERATED BY (USED IN):
Operating Activities:
Depreciation
86,115
967,490
572,211
638,261
Breakage of bottles and cases
24,359
273,670
200,801
208,212
Goodwill amortization and impairment
497,829
Amortization and other
67,214
755,154
310,352
152,818
385,258
4,328,367
4,241,994
3,433,483
Working capital:
Accounts receivable
18,497
207,809
197,145
(188,522
Inventories
(33,164
(372,600
(226,701
(152,897
Prepaid expenses and recoverable taxes
(52,460
(589,387
(590,382
16,353
Suppliers
(11,710
(131,562
59,449
279,758
Accounts payable and other
(84,825
(953,004
214,441
(39,490
Accrued taxes
(9,591
(107,754
113,481
162,945
Interest payable
14,654
164,643
5,106
(6,640
Pension plan and seniority premiums
(2,716
(30,513
(9,552
15,081
NET RESOURCES GENERATED BY OPERATING ACTIVITIES
223,943
2,515,999
4,004,981
3,520,071
Investing Activities:
Panamerican Beverages, Inc. acquisition
(2,638,932
(29,648,404
Property, plant and equipment
(138,403
(1,554,957
(919,585
(770,242
Retirements of property, plant and equipment
134,591
Investments in shares and other assets
(31,637
(355,448
(490,121
(229,650
NET RESOURCES USED IN INVESTING ACTIVITIES
(2,808,972
(31,558,809
(1,409,706
(865,301
Financing Activities:
Amortization in real terms of financing
80,693
906,587
245,402
(281,186
Translation adjustment in foreign subsidiaries
(34,580
(388,501
(515,251
641,181
Proceeds from issuance of long-term debt
1,388,417
15,598,869
(21,638
(19,329
Dividends paid
(608,260
(331,447
Other liabilities
(48,057
(539,903
19,194
133,888
Increase in capital stock
874,014
9,819,542
NET RESOURCES OBTAINED FROM (USED IN) FINANCING ACTIVITIES
2,260,487
25,396,594
(880,553
143,107
Decrease in cash and cash equivalents
(324,542
(3,646,216
1,714,722
2,797,877
Cash and cash equivalents at beginning of the year
572,271
6,429,449
4,714,727
1,916,850
CASH AND CASH EQUIVALENTS AT END OF THE YEAR
247,729
2,783,233
The accompanying notes are an integral part of these consolidated statements of changes in financial position.
Transfer of additional paid in capital to capital stock
Balance at the beginning of the year
11,889
8,888
Provision for the year
45,154
18,891
Write-offs
(14,929)
(15,439)
Panamco allowance at date of acquisition
61,736
Restatement of the balance at the beginning of the year
(864)
(451)
Balance at the end of the year
102,986
Finished products
565,500
220,988
Raw materials
1,210,939
264,031
Spare parts
323,690
86,171
Advances to suppliers
145,104
227,011
Work in process
16,487
1,661
Advertising and promotional materials
24,317
4,807
Allowance for obsolescence
(99, 362)
(6,034)
2,186,675
798,635
Advertising and promotional expenses
164,011
52,810
Bonus
15,200
Insurance
8,537
2,150
Other
14,267
21,559
202,015
76,519
Advertising
784,761
512,012
524,422
Promotional expenses
77,301
126,330
108,914
Land
2,484,283
819,901
Buildings, machinery and equipment
24,059,383
9,373,780
Accumulated depreciation
(10,385,578)
(3,441,413)
Construction in progress
671,374
381,477
Bottles and cases
947,315
302,793
17,776,777
7,436,538
Refrigeration equipment
856,848
414,428
Long-term notes
22,348
Leasehold improvements
32,574
28,844
Additional labor liability (see Note 15)
23,342
13,123
Yankee bond
47,099
24,161
140,685
75,170
Commissions
127,399
271,883
127,533
57,530
1,377,828
885,139
Unamortized Intangible Assets
Rights to produce and distribute Coca-Cola trademark products:
Panamco territories (see Note 2)
33,419,830
Coca-Cola FEMSA de Buenos Aires
189,962
158,099
Tapachula, Chiapas territory
111,287
110,647
33,721,079
268,746
Balance Sheet
Assets (accounts receivable)
64,490
19,413
Liabilities (suppliers and other liabilities)
268,131
208,128
Income:
Sales and other revenues
173,484
145,493
123,127
Expenses:
Purchases of inventories
1,083,679
858,804
572,740
1,009,887
686,452
652,706
255,114
120,188
716,625
330,512
Transactions
Purchases of concentrate
5,613,563
2,725,193
2,805,980
8,063
15,201
24,172
101
Liabilities (suppliers)
46,748
29,910
Transactions:
34,346
68,049
71,517
Purchases of Products from:
IEQSA
253,260
178,635
447,032
CICAN
28,215
80,709
156,576
Tapon Corona de Colombia, S.A.
43,844
Distribuidora Plastica, S.A.
2,610
Metalforma, S.A.
2,362
Vidrios Panameños, S.A.
6,660
Beta San Miguel, S.A. de C.V.
221,179
Balances
Applicable Exchange Rate (1)
Short-Term
Long-Term
December 31, 2003:
Assets
11.2350
79,553
Liabilities
283,227
1,054,917
1,338,144
December 31, 2002:
10.4590
320,660
7,763
303,070
310,833
5,182
2,931
2,333
Interest expenses and commissions
184,059
28,043
28,809
(178,877)
(25,112)
(26,476)
AnnualDiscountRate
SalaryIncrease
Return onAssets
6.0%
1.5%
5.5%
(1)
Measurement date
November 30, 2003
Pension and Retirement Plans: Vested benefit obligation
Non-vested benefit obligation
397,258
93,592
Accumulated benefit obligation
623,677
154,446
Excess of projected benefit obligation over accumulated benefit Obligation
78,583
27,239
Projected benefit obligation
702,260
181,685
Pension plan funds at fair value
(206,408)
(36,732)
Unfunded projected benefit obligation
495,852
144,953
Unrecognized net transition obligation services
(14,644)
(14,825)
Unrecognized actuarial net gain
38,511
41,155
519,719
171,283
Additional labor liability
7,547
527,266
Fixed Rate:
Traded securities
34%
16%
Bank instruments
11%
Federal government instruments
30%
Variable Rate.
Publicly-traded shares
25%
20%
100%
Thousands ofshares
844,078
731,546
270,750
1,846,374
820,503
1,834,950
2,655,453
Additional paid-in capital
9,703,375
1,658,064
11,361,439
Retained earnings from prior years
6,709,610
2,741,008
9,450,618
2,242,280
69,562
Statutorytax rate
34.0%
35.0%
38.5%
30.0%
31.0%
Tax loss carryforward expiration
5
(a)
(b)
(c)
Balance at beginning of the year
847,974
651,885
Balance acquisition of Panamco
(934,274)
492,082
121,950
Change in the statutory income tax rate
(37,666)
(42,966)
Result of holding non-monetary assets
8,334
117,105
Balance at end of the year
376,450
Current income taxes
982,052
1,696,601
1,325,688
Deferred income taxes
454,416
78,984
66,024
Employee profit sharing
221,761
136,528
135,031
Mexican statutory income tax rate
34.00%
35.00%
Gain from monetary position
(6.26)
(3.06)
(0.75)
Inflationary component
6.16
0.58
0.97
Non-deductible expenses and other
3.18
0.95
(0.15)
Income taxed at other than Mexican statutory rate
(1.08)
1.92
0.77
Goodwill impairment
3.44
Consolidated effective tax rate
36.00%
38.83%
35.84%
26,532,616
925,505
Central America(1)
2,802,024
1,101,099
3,157,766
1,305,798
199,604
228,380
6,507,368
1,061,031
1,583,168
Consolidation adjustments
17,086,669
Cash Flows(1)
2,228,881
2,524,210
2,250,232
Non-cash items
2,750,821
966,682
1,055,704
Other expenses
22,691
377,531
39,729
Working capital investment
(2,553,018)
154,140
320,511
Net cash flows from operating activities
2,449,375
4,022,563
3,666,176
Panamco acquisition
(29,191,840)
Fixed and other assets investments
(1,914,774)
(1,170,060)
(777,895)
Total investing activities
(31,106,614)
Financial expenses
30,823
30,169
5,643
Bank loans
15,889,909
(10,805)
(24,697)
Capital increase
9,584,874
(561,023)
(292,125)
Other financial transactions
(1,017,345)
(407,225)
184,868
Net cash flows used in financing activities
24,488,261
(948,884)
(126,311)
Net increase in cash and cash equivalents
(4,168,978)
1,903,619
2,761,970
Effect of exchange rate changes on cash
147,634
(194,551)
(316,356)
Cash and cash equivalents from Panamco acquisition
633,183
Cash and cash equivalents at the beginning of the year
6,171,394
4,462,326
2,016,712
Cash and cash equivalents at the end of the year
Interest paid
1,124,895
42,847
38,610
Income tax and tax on assets paid
1,588,809
1,873,150
1,408,205
Stockholders’ equity at the beginning of the year
9,294,415
8,208,275
Dividends declared and paid
(608,260)
Cumulative translation adjustment
(207,046)
(702,897)
910,737
(227,075)
Other comprehensive income
(67,147)
2,298,443
2,624,372
Stockholders’ equity at the end of the year
22,048,944
Net majority income under Mexican GAAP
US GAAP adjustments:
Restatement of prior year financial statements (Note 25 a)
5,384
140,208
Deferred promotional expenses (Note 25 c)
(100,923)
(10,697)
Intangible assets (Note 25 d)
38,819
Restatement of imported machinery and equipment (Note 25 e)
(13,651)
(6,770)
Capitalization of the integral result of financing (Note 25 f)
(5,847)
(690)
18,466
Financial instruments (Note 25 g)
7,396
(4,815)
Deferred income taxes (Note 25 h)
115,947
50,991
3,523
Deferred employee profit sharing (Note 25 h)
(36,257)
(100,660)
(89,769)
Pension plan (Note 25 i)
(1,478)
(1,110)
391
Total adjustments
(13,399)
(36,429)
66,049
Net income under US GAAP
2,391,988
Majority stockholders’ equity under Mexican GAAP
22,653,118
9,668,141
(181,437)
(111,212)
(94,376)
233,427
71,073
76,920
Other comprehensive income (Note 25 g)
(97,456)
75,419
(109,134)
(491,351)
(420,090)
4,910
3,281
(604,174)
(373,726)
Stockholders’ equity under US GAAP
Majority comprehensive income under Mexican GAAP
3,165,435
2,113,205
2,284,254
Net income (Note 26 a)
Translation adjustment
(1,681,531)
57,144
320,521
429,859
Comprehensive income under US GAAP
2,934,987
1,694,400
1,098,631
(Unaudited; in thousands, except per share amounts)
43,710,952
43,970,241
44,006,113
44,223,606
2,766,723
3,530,583
Earnings per share
1.50
1.91