KOF

Business Context and Reporting Period

Company: Coca-Cola FEMSA, S.A. de C.V.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal Year Ended December 31, 2005
Accounting Basis: Mexican GAAP (with U.S. GAAP reconciliation provided)
Overview: The company is the largest bottler of Coca-Cola trademark beverages in Latin America and the second largest in the world by sales volume. Operations span Mexico, Central America (Guatemala, Nicaragua, Costa Rica, Panama), Colombia, Venezuela, Brazil, and Argentina. The 2005 results include the full year of operations for territories acquired in the 2003 Panamco acquisition.

Key Financial Metrics (2005)

Note: U.S. Dollar amounts are translated at the year-end rate of Ps. 10.6275 to US$ 1.00.

Material Changes vs. Prior Period (2004)

• Revenue Growth: Total revenues increased 5.0% to Ps. 50,198 million, driven primarily by volume growth in Mexico, Brazil, and Colombia. Consolidated sales volume rose 4.3% to 1,889.2 million unit cases.
• Profitability Decline: Despite revenue growth, Majority Net Income decreased 17.8% to Ps. 4,586 million. This decline was primarily due to a one-time tax benefit of Ps. 1,355 million recognized in 2004 from a tax lawsuit, which was not repeated in 2005. Excluding this non-recurring item, net income would have increased 13.8%.
• Operating Margin Expansion: Operating income increased 8.7% to Ps. 8,683 million. The overall operating margin improved by 60 basis points to 17.3%, aided by higher fixed-cost absorption and stable average costs.
• Segment Performance:
  • Brazil: Strongest performer with 12.0% revenue growth and 72.2% operating income growth.
  • Venezuela: Operating income declined significantly due to higher raw material costs, currency devaluation, and operating difficulties limiting supply.
  • Central America: Revenues declined 2.8% due to a competitive environment and lower average prices.
• Debt Reduction: Total indebtedness decreased from Ps. 25,836 million in 2004 to Ps. 20,101 million in 2005.

Guidance, Outlook, and Risks

• Capital Expenditures: Management estimates 2006 capital expenditures at approximately US$ 250 million (Ps. 2,656 million), focused on returnable bottles, refrigeration equipment, and logistics improvements. Internally generated funds are expected to be sufficient.
• Concentrate Price Increases: The Coca-Cola Company announced gradual concentrate price increases for carbonated soft drinks starting in 2006 in Brazil and 2007 in Mexico. The company expects incremental annual costs of approximately US$ 20 million in Mexico by 2007 and US$ 1.0 million in Brazil by 2006, rising over subsequent years.
• Key Risks:
  • Relationship with The Coca-Cola Company: Approximately 96% of sales volume is derived from Coca-Cola trademark beverages. The company relies on the renewal of bottler agreements, several of which expire in 2006 (Guatemala, Nicaragua, Colombia, Venezuela).
  • Raw Material Costs: Prices for resin (tied to crude oil) and sugar are volatile. Resin prices in Mexico increased over 25% in 2005. Sugar shortages were experienced in Venezuela.
  • Foreign Exchange: A depreciation of the Mexican peso or local currencies in operating territories against the U.S. dollar increases costs for imported raw materials and U.S. dollar-denominated debt.
  • Regulatory and Political: Risks include potential new taxes on soft drinks, price controls, and political instability in Venezuela and Argentina.

Investor Verification Checklist

• Non-Recurring Tax Items: Verify the impact of the 2004 one-time tax benefit on year-over-year earnings comparisons; the 2005 effective tax rate (35.4%) is significantly higher than 2004 (16.9%) due to the absence of this benefit.
• Concentrate Pricing: Monitor the implementation of announced concentrate price hikes in Brazil (2006) and Mexico (2007) and the company's ability to pass these costs to consumers.
• Bottler Agreement Renewals: Track the status of bottler agreement renewals expiring in 2006 for Colombia, Venezuela, Guatemala, and Nicaragua.
• Venezuela Operations: Assess the impact of ongoing economic instability, currency controls, and sugar shortages on the Venezuela segment's profitability and cash flow.
• U.S. GAAP Reconciliation: Review Note 26 for significant differences between Mexican GAAP and U.S. GAAP, particularly regarding inflation accounting, intangible assets, and deferred taxes, which result in lower U.S. GAAP net income (Ps. 4,455 million) compared to Mexican GAAP (Ps. 4,704 million).