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Pepsi Bottling Group 10-K 2006 Documents found in this filing:
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the Fiscal Year Ended December 31, 2005
or
For the transition period from _________to _________
Commission
file number 1-14893
The Pepsi Bottling Group, Inc.
(Exact name of Registrant as Specified in its Charter)
Registrant’s
telephone number, including area code:
(914) 767-6000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act.
Yes þ No o Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the
Act.
Yes o No þ Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form
10-K. o
Indicated by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See
definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act.
Large accelerated
filer
þ Accelerated
filer o
Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The number of shares of Capital Stock of The Pepsi Bottling Group, Inc. outstanding as of
February 15, 2006 was 237,237,138. The aggregate market value of The Pepsi Bottling Group, Inc.
Capital Stock held by non-affiliates of The Pepsi Bottling Group, Inc. as of June 11, 2005 was
$4,053,664,844.
TABLE OF CONTENTS
Table of Contents
PART I
Item 1. Business
Introduction
The Pepsi Bottling Group, Inc. (“PBG”) was incorporated in Delaware in January, 1999, as a
wholly owned subsidiary of PepsiCo, Inc. (“PepsiCo”) to effect the separation of most of PepsiCo’s
company-owned bottling businesses. PBG became a publicly traded company on March 31, 1999. As of
January 27, 2006 PepsiCo’s ownership represented 41.3% of the outstanding common stock and 100% of
the outstanding Class B common stock, together representing 46.9% of the voting power of all
classes of PBG’s voting stock. PepsiCo also owned approximately 6.7% of the equity interest of
Bottling Group, LLC, PBG’s principal operating subsidiary, as of January 27, 2006. We refer to our
publicly traded common stock as “Common Stock” and, together with our Class B common stock, as our
“Capital Stock.” When used in this Report, “PBG,” “we,” “us” and “our” each refers to The Pepsi
Bottling Group, Inc. and, where appropriate, to Bottling Group, LLC, which we also refer to as
“Bottling LLC.”
We maintain a website at http://www.pbg.com. We make available, free of charge, through the
Investor Relations — Financial Information — SEC filings section of our website, our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed
with, or furnished to, the Securities and Exchange Commission (the “SEC”). Additionally, we have
made available, free of charge, the following governance materials on our website at
http://www.pbg.com under Investor Relations — Company
Information — Corporate
Governance: Certificate of Incorporation, Bylaws, Corporate Governance Principles and Practices,
Worldwide Code of Conduct (including any amendment thereto), Director Independence Policy, the
Audit and Affiliated Transactions Committee Charter, the Compensation and Management Development
Committee Charter, the Nominating and Corporate Governance Committee Charter and the Disclosure
Committee Charter. These governance materials are available in print, free of charge, to any PBG
shareholder upon request.
Principal Products
PBG is the world’s largest manufacturer, seller and distributor of Pepsi-Cola beverages. The
beverages sold by us include Pepsi-Cola, Diet Pepsi, Mountain Dew,
Aquafina, Lipton Brisk, Sierra Mist, Diet Mountain Dew, Tropicana Juice Drinks, SoBe, and
Starbucks Frappuccino. In addition to the foregoing, the beverages we sell
outside the U.S. include 7
up,
Kas, Aqua Minerale, Mirinda and Manzanita sol.
In some of our territories, we have the right to manufacture, sell and distribute soft drink
products of companies other than PepsiCo, including Dr pepper and Squirt. We also
have the right in some of our territories to manufacture, sell and distribute beverages under
trademarks that we own, including Electropura, Epura and Garci Crespo.
We have the exclusive right to manufacture, sell and distribute Pepsi-Cola beverages in all or
a portion of 41 states and the District of Columbia in the U.S., nine Canadian provinces, Spain,
Greece, Russia, Turkey and all or a portion of 23 states in Mexico. In 2005, approximately 71% of
our net revenues were generated in the United States, 10% of our net revenues were generated in
Mexico and the remaining 19% of our net revenues were generated in Canada, Spain, Greece, Russia
and Turkey. In 2005, worldwide sales of our products to two of our customers accounted for
approximately 10% of our net revenues. We have an extensive direct store distribution system in the
United States, Mexico and Canada. In Russia, Spain, Greece and Turkey, we use a combination of
direct store distribution and distribution through wholesalers, depending on local marketplace
considerations.
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Raw Materials and Other Supplies
We purchase the concentrates to manufacture Pepsi-Cola beverages and other beverage products
from PepsiCo and other beverage companies.
In addition to concentrates, we purchase sweeteners, glass and plastic bottles, cans,
closures, syrup containers, other packaging materials, carbon dioxide and some finished goods. We
generally purchase our raw materials, other than concentrates, from multiple suppliers. PepsiCo
acts as our agent for the purchase of such raw materials in the United States and Canada and, with
respect to some of our raw materials, in certain of our international markets. The Pepsi beverage
agreements, as described below, provide that, with respect to the beverage products of PepsiCo, all
authorized containers, closures, cases, cartons and other packages and labels may be purchased only
from manufacturers approved by PepsiCo. There are no materials or supplies used by PBG that are
currently in short supply. The supply or cost of specific materials could be adversely affected by
various factors, including price changes, strikes, weather conditions and governmental controls.
Patents, Trademarks and Licenses
Our portfolio of beverage products includes some of the best recognized trademarks in the
world and includes Pepsi-Cola, Diet Pepsi, Mountain Dew, Aquafina,
Lipton Brisk, Sierra Mist, Diet Mountain Dew, Tropicana Juice Drinks, SoBe, and
Starbucks Frappuccino. In addition to the foregoing, the
beverages we sell outside the U.S. include 7 up, Kas, Aqua Minerale, Mirinda
and Manzanita Sol. In some of our territories, we have the right to manufacture,
sell and distribute beverage products of companies other than PepsiCo, including Dr Pepper
and Squirt. We also have the right in some of our territories to manufacture, sell
and distribute beverages under trademarks that we own, including Electropura,
Epura and Garci Crespo. The majority of our volume is derived from brands
licensed from PepsiCo or PepsiCo joint ventures.
We conduct our business primarily under agreements with PepsiCo. These agreements give us the
exclusive right to market, distribute, and produce beverage products of PepsiCo in authorized
containers in specified territories.
Set forth below is a description of the Pepsi beverage agreements and other bottling
agreements to which we are a party.
Terms of the Master Bottling Agreement. The Master Bottling Agreement under which we
manufacture, package, sell and distribute the cola beverages bearing the Pepsi-Cola and
Pepsi trademarks in the U.S. was entered into in March of 1999. The Master Bottling
Agreement gives us the exclusive and perpetual right to distribute cola beverages for sale in
specified territories in authorized containers of the nature currently used by us. The Master
Bottling Agreement provides that we will purchase our entire requirements of concentrates for the
cola beverages from PepsiCo at prices, and on terms and conditions, determined from time to time by
PepsiCo. PepsiCo may determine from time to time what types of containers to authorize for use by
us. PepsiCo has no rights under the Master Bottling Agreement with respect to the prices at which
we sell our products.
Under the Master Bottling Agreement we are obligated to:
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The Master Bottling Agreement requires us to meet annually with PepsiCo to discuss plans for
the ensuing year and the following two years. At such meetings, we are obligated to present plans
that set out in reasonable detail our marketing plan, our management plan and advertising plan with
respect to the cola beverages for the year. We must also present a financial plan showing that we
have the financial capacity to perform our duties and obligations under the Master Bottling
Agreement for that year, as well as sales, marketing, advertising and capital expenditure plans for
the two years following such year. PepsiCo has the right to approve such plans, which approval
shall not be unreasonably withheld. In 2005, PepsiCo approved our plans.
If we carry out our annual plan in all material respects, we will be deemed to have satisfied
our obligations to push vigorously the sale of the cola beverages, increase and fully meet the
demand for the cola beverages in our territories and maintain the financial capacity required under
the Master Bottling Agreement. Failure to present a plan or carry out approved plans in all
material respects would constitute an event of default that, if not cured within 120 days of notice
of the failure, would give PepsiCo the right to terminate the Master Bottling Agreement.
If we present a plan that PepsiCo does not approve, such failure shall constitute a primary
consideration for determining whether we have satisfied our obligations to maintain our financial
capacity, push vigorously the sale of the cola beverages and increase and fully meet the demand for
the cola beverages in our territories.
If we fail to carry out our annual plan in all material respects in any segment of our
territory, whether defined geographically or by type of market or outlet, and if such failure is
not cured within six months of notice of the failure, PepsiCo may reduce the territory covered by
the Master Bottling Agreement by eliminating the territory, market or outlet with respect to which
such failure has occurred.
PepsiCo has no obligation to participate with us in advertising and marketing spending, but it
may contribute to such expenditures and undertake independent advertising and marketing activities,
as well as cooperative advertising and sales promotion programs that would require our cooperation
and support. Although PepsiCo has advised us that it intends to continue to provide cooperative
advertising funds, it is not obligated to do so under the Master Bottling Agreement.
The Master Bottling Agreement provides that PepsiCo may in its sole discretion reformulate any
of the cola beverages or discontinue them, with some limitations, so long as all cola beverages are
not discontinued. PepsiCo may also introduce new beverages under the Pepsi-Cola trademarks
or any modification thereof. When that occurs, we are obligated to manufacture, package, distribute
and sell such new beverages with the same obligations as then exist with respect to other cola
beverages. We are prohibited from producing or handling cola products, other than those of PepsiCo,
or products or packages that imitate, infringe or cause confusion with the products, containers or
trademarks of PepsiCo. The Master Bottling Agreement also imposes requirements with respect to the
use of PepsiCo’s trademarks, authorized containers, packaging and labeling.
If we acquire control, directly or indirectly, of any bottler of cola beverages, we must cause
the acquired bottler to amend its bottling appointments for the cola beverages to conform to the
terms of the Master Bottling Agreement.
Under the Master Bottling Agreement, PepsiCo has agreed not to withhold approval for any
acquisition of rights to manufacture and sell Pepsi trademarked cola beverages within a
specific area — currently representing approximately 11.3% of PepsiCo’s U.S. bottling system in
terms of volume — if we have successfully negotiated the acquisition and, in PepsiCo’s reasonable
judgment, satisfactorily performed our obligations under the Master Bottling Agreement. We have
agreed not to acquire or attempt
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to acquire any rights to manufacture and sell Pepsi trademarked cola beverages outside of
that specific area without PepsiCo’s prior written approval.
The Master Bottling Agreement is perpetual, but may be terminated by PepsiCo in the event of
our default. Events of default include:
An event of default will also occur if any person or affiliated group acquires any contract,
option, conversion privilege, or other right to acquire, directly or indirectly, beneficial
ownership of more than 15% of any class or series of our voting securities without the consent of
PepsiCo. As of February 15, 2006, to our knowledge, no shareholder of PBG, other than PepsiCo, held
more than 10.2% of our Common Stock.
We are prohibited from assigning, transferring or pledging the Master Bottling Agreement, or
any interest therein, whether voluntarily, or by operation of law, including by merger or
liquidation, without the prior consent of PepsiCo.
The Master Bottling Agreement was entered into by us in the context of our separation from
PepsiCo and, therefore, its provisions were not the result of arm’s-length negotiations.
Consequently, the agreement contains provisions that are less favorable to us than the exclusive
bottling appointments for cola beverages currently in effect for independent bottlers in the United
States.
Terms of the Non-Cola Bottling Agreements. The beverage products covered by the non-cola
bottling agreements are beverages licensed to us by PepsiCo, consisting of Mountain Dew,
Aquafina, Sierra Mist, Diet Mountain Dew, Mug root beer and cream soda, Mountain Dew Code
Red and Slice. The non-cola bottling agreements contain provisions that are similar
to those contained in the Master Bottling Agreement with respect to pricing, territorial
restrictions, authorized containers, planning, quality control, transfer restrictions, term and
related matters. Our non-cola bottling agreements will terminate if PepsiCo terminates our Master
Bottling Agreement. The exclusivity provisions contained in the non-cola bottling agreements would
prevent us from manufacturing, selling or distributing beverage products which imitate, infringe
upon, or cause confusion with, the beverage products covered by the non-cola bottling agreements.
PepsiCo may also elect to discontinue the manufacture, sale or distribution of a non-cola beverage
and terminate the applicable non-cola bottling agreement upon six months notice to us.
Terms of Certain Distribution Agreements. We also have agreements with PepsiCo granting us
exclusive rights to distribute Amp and Dole in all of our territories and
SoBe in certain specified territories. The distribution agreements contain provisions
generally similar to those in the Master Bottling Agreement as to use of trademarks, trade names,
approved containers and labels and causes for termination. We also have the right to sell and
distribute Gatorade in Spain, Greece and Russia and in certain limited channels of
distribution in the U.S. and Canada. Some of these beverage agreements have limited terms and, in
most instances, prohibit us from dealing in similar beverage products. We are also currently
distributing Tropicana Juice Drinks in the United States and Canada and Tropicana
Juices in Russia and Spain.
Terms of the Master Syrup Agreement. The Master Syrup Agreement grants us the exclusive right
to manufacture, sell and distribute fountain syrup to local customers in our territories. The
Master Syrup Agreement also grants us the right to act as a manufacturing and delivery agent for
national accounts
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within our territories that specifically request direct delivery without using a middleman. In
addition, PepsiCo may appoint us to manufacture and deliver fountain syrup to national accounts
that elect delivery through independent distributors. Under the Master Syrup Agreement, we have
the exclusive right to service fountain equipment for all of the national account customers within
our territories. The Master Syrup Agreement provides that the determination of whether an account
is local or national is at the sole discretion of PepsiCo.
The Master Syrup Agreement contains provisions that are similar to those contained in the
Master Bottling Agreement with respect to concentrate pricing, territorial restrictions with
respect to local customers and national customers electing direct-to-store delivery only, planning,
quality control, transfer restrictions and related matters. The Master Syrup Agreement had an
initial term of five years which expired in 2004 and was renewed for an additional five-year
period. The Master Syrup Agreement will automatically renew for additional five-year periods,
unless PepsiCo terminates it for cause. PepsiCo has the right to terminate the Master Syrup
Agreement without cause at any time upon twenty-four months notice. In the event PepsiCo terminates
the Master Syrup Agreement without cause, PepsiCo is required to pay us the fair market value of
our rights thereunder.
Our Master Syrup Agreement will terminate if PepsiCo terminates our Master Bottling Agreement.
Terms of Other U.S. Bottling Agreements. The bottling agreements between us and other
licensors of beverage products, including Cadbury Schweppes plc for Dr Pepper, Schweppes,
Canada Dry, Hawaiian Punch and Squirt, the Pepsi/Lipton Tea Partnership for
Lipton Brisk and Lipton’s Iced Tea, and the North American Coffee
Partnership for Starbucks Frappuccino, contain provisions generally similar to those in
the Master Bottling Agreement as to use of trademarks, trade names, approved containers and labels,
sales of imitations and causes for termination. Some of these beverage agreements have limited
terms and, in most instances, prohibit us from dealing in similar beverage products.
Terms of the Country Specific Bottling Agreements. The country specific bottling agreements
contain provisions generally similar to those contained in the Master Bottling Agreement and the
non-cola bottling agreements and, in Canada, the Master Syrup Agreement with respect to authorized
containers, planning, quality control, transfer restrictions, term, causes for termination and
related matters. These bottling agreements differ from the Master Bottling Agreement because,
except for Canada, they include both fountain syrup and non-fountain beverages. Certain of these
bottling agreements contain provisions that have been modified to reflect the laws and regulations
of the applicable country. For example, the bottling agreements in Spain do not contain a
restriction on the sale and shipment of Pepsi-Cola beverages into our territory by others in
response to unsolicited orders. In addition, in Mexico and Turkey we are restricted in our ability
to manufacture, sell and distribute beverages sold under non-PepsiCo trademarks.
Seasonality
Our peak season is the warm summer months beginning in May and ending in September. More than
65% of our operating income is typically earned during the second and third quarters. More than
80% of cash flow from operations is typically generated in the third and fourth quarters.
Competition
The carbonated soft drink market and the non-carbonated beverage market are highly
competitive. Our competitors in these markets include bottlers and distributors of nationally
advertised and marketed products, bottlers and distributors of regionally advertised and marketed
products, as well as bottlers of private label soft drinks sold in chain stores. Among our major
competitors are bottlers that distribute products from The Coca-Cola Company including Coca-Cola
Enterprises Inc., Coca-Cola Hellenic Bottling Company S.A., Coca-Cola FEMSA S.A. de C.V. and
Coca-Cola Bottling Co. Consolidated. Our market share for carbonated soft drinks sold under
trademarks owned by PepsiCo in our U.S. territories ranges from approximately 21% to approximately
37%. Our market share for carbonated soft drinks sold under trademarks owned by PepsiCo for each
country, outside the U.S., in which we do business is as follows:
Canada 38%; Russia 25%; Turkey
19%; Spain 12% and Greece 9% (including market share
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for our ivi brand). In addition, market share for our territories and the territories of
other Pepsi bottlers in Mexico is 13% for carbonated soft drinks sold under trademarks owned by
PepsiCo. All market share figures are based on generally available data published by third-parties.
Actions by our major competitors and others in the beverage industry, as well as the general
economic environment, could have an impact on our future market share.
We compete primarily on the basis of advertising and marketing programs to create brand
awareness, price and promotions, retail space management, customer service, consumer points of
access, new products, packaging innovations and distribution methods. We believe that brand
recognition, market place pricing, consumer value, customer service, availability and consumer and
customer goodwill are primary factors affecting our competitive position.
Governmental Regulation Applicable to PBG
Our operations and properties are subject to regulation by various federal, state and local
governmental entities and agencies in the United States as well as foreign governmental entities
and agencies in Canada, Spain, Greece, Russia, Turkey and Mexico. As a producer of food products,
we are subject to production, packaging, quality, labeling and distribution standards in each of
the countries where we have operations, including, in the United States, those of the Federal Food,
Drug and Cosmetic Act and the Public Health Security and Bioterrorism Preparedness and Response
Act. The operations of our production and distribution facilities are subject to laws and
regulations relating to the protection of our employees’ health and safety and the environment in
the countries in which we do business. In the United States, we are subject to the laws and
regulations of various governmental entities, including the Department of Labor, the Environmental
Protection Agency and the Department of Transportation, and various federal, state and local
occupational, labor and employment and environmental laws. These laws and regulations include the
Occupational Safety and Health Act, the Clean Air Act, the Clean Water Act, the Resource
Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability
Act, the Superfund Amendments and Reauthorization Act, the Federal Motor Carrier Safety Act and the
Fair Labor Standards Act.
We believe that our current legal, operational and environmental compliance programs are
adequate and that we are in substantial compliance with applicable laws and regulations of the
countries in which we do business. We do not anticipate making any material expenditures in
connection with environmental remediation and compliance. However, compliance with, or any
violation of, future laws or regulations could require material expenditures by us or otherwise
have a material adverse effect on our business, financial condition or results of operations.
Bottle and Can Legislation
Legislation has been enacted in certain states and Canadian provinces where we operate that
generally prohibits the sale of certain beverages in non-refillable containers unless a deposit or
levy is charged for the container. These include California, Connecticut, Delaware, Hawaii, Iowa,
Maine, Massachusetts, Michigan, New York, Oregon, West Virginia, British Columbia, Alberta,
Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Ontario, Prince Edward Island and Quebec.
Massachusetts and Michigan have statutes that require us to pay all or a portion of unclaimed
container deposits to the state and Hawaii and California impose a levy on beverage containers to
fund a waste recovery system.
In addition to the Canadian deposit legislation described above, Ontario, Canada currently has
a regulation requiring that at least 30% of all soft drinks sold in Ontario be bottled in
refillable containers.
The European Commission issued a packaging and packing waste directive that was incorporated
into the national legislation of most member states. This has resulted in targets being set for the
recovery and recycling of household, commercial and industrial packaging waste and imposes
substantial responsibilities upon bottlers and retailers for implementation. Similar legislation
has been enacted in Turkey.
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Mexico adopted legislation regulating the disposal of solid waste products. In response to
this legislation, PBG Mexico maintains agreements with local and federal Mexican governmental
authorities as well as with civil associations, which require PBG Mexico, and other participating
bottlers, to provide for collection and recycling of certain minimum amounts of plastic bottles.
We are not aware of similar material legislation being enacted in any other areas served by
us. We are unable to predict, however, whether such legislation will be enacted or what impact its
enactment would have on our business, financial condition or results of operations.
Soft Drink Excise Tax Legislation
Specific soft drink excise taxes have been in place in certain states for several years. The
states in which we operate that currently impose such a tax are West Virginia and Arkansas and,
with respect to fountain syrup only, Washington. In Mexico, there are excise taxes on any
sweetened beverage products produced without sugar, including our diet soft drinks and imported
beverages that are not sweetened with sugar.
Value-added taxes on soft drinks vary in our territories located in Canada, Spain, Greece,
Russia, Turkey and Mexico, but are consistent with the value-added tax rate for other consumer
products. In addition, there is a special consumption tax applicable to cola products in Turkey.
In Mexico, bottled water in containers over 10.1 liters are exempt from value-added tax, and PBG
obtained a tax exemption for containers holding less than 10.1 liters of water.
We are not aware of any material soft drink taxes that have been enacted in any other market
served by us. We are unable to predict, however, whether such legislation will be enacted or what
impact its enactment would have on our business, financial condition or results of operations.
Trade Regulation
As a manufacturer, seller and distributor of bottled and canned soft drink products of PepsiCo
and other soft drink manufacturers in exclusive territories in the United States and
internationally, we are subject to antitrust and competition laws. Under the Soft Drink Interbrand
Competition Act, soft drink bottlers operating in the United States, such as us, may have an
exclusive right to manufacture, distribute and sell a soft drink product in a geographic territory
if the soft drink product is in substantial and effective competition with other products of the
same class in the same market or markets. We believe that there is such substantial and effective
competition in each of the exclusive geographic territories in which we operate.
School Sales Legislation; Industry Guidelines
In 2004, Congress passed the Child Nutrition Act which requires school districts to implement
a school wellness policy by July 2006. As of December 2005, several school districts in PBG’s
bottling territories have imposed restrictions on soft drink sales in schools. Additionally,
several states have enacted restrictions on soft drink sales in schools. Members of the American
Beverage Association have endorsed a school vending policy (the “ABA Policy”) that limits the types
of beverages sold in elementary, middle and high schools. Also, the beverage association in the
European Union and various provinces in Canada have recently issued guidelines relating to the sale
of beverages in schools. PBG intends to fully comply with the ABA Policy and these guidelines.
California Carcinogen and Reproductive Toxin Legislation
A California law requires that any person who exposes another to a carcinogen or a
reproductive toxin must provide a warning to that effect. Because the law does not define
quantitative thresholds below which a warning is not required, virtually all manufacturers of food
products are confronted with the possibility of having to provide warnings due to the presence of
trace amounts of defined substances. Regulations implementing the law exempt manufacturers from
providing the required warning if it can be demonstrated that the defined substances occur
naturally in the product or are present in municipal water used to manufacture the product. We
have assessed the impact of the law and its implementing regulations on our beverage products and
have concluded that none of our products currently require a
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warning under the law. We cannot predict whether or to what extent food industry efforts to
minimize the law’s impact on food products will succeed. We also cannot predict what impact,
either in terms of direct costs or diminished sales, imposition of the law may have.
Mexican Water Regulation
In Mexico, we pump water from our own wells and we purchase water directly from municipal
water companies pursuant to concessions obtained from the Mexican government on a plant-by-plant
basis. The concessions are generally for 10-year terms and can generally be renewed by us prior to
expiration with minimal cost and effort. Our concessions may be terminated if, among other things,
(a) we use materially more water than permitted by the concession, (b) we use materially less water
than required by the concession, (c) we fail to pay for the rights for water usage or (d) we carry
out, without government authorization, any material construction on or improvement to, our wells.
Our concessions generally satisfy our current water requirements and we believe that we are
generally in compliance in all material respects with the terms of our existing concessions.
Employees
As of December 31, 2005, we employed approximately 66,900 workers, of whom approximately
33,000 were employed in the United States. Approximately 8,900 of our workers in the United States
are union members and approximately 17,300 of our workers outside the United States are union
members. We consider relations with our employees to be good and have not experienced significant
interruptions of operations due to labor disagreements.
Financial Information on Industry Segments and Geographic Areas
See
Note 15 to PBG’s Consolidated Financial Statements included in Item 7 below.
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Item 1A. Risk Factors
Our Business and operations entail a variety of risks and uncertainties, including those described
below.
We may not be able to respond successfully to consumer trends related to carbonated and
non-carbonated beverages.
Consumers are seeking increased variety in their beverages, and there is a growing interest
among the public regarding health and wellness issues. This interest has resulted in a decline in
consumer demand for full calorie carbonated soft drinks and an increase in consumer demand for
products associated with health and wellness, such as water, reduced calorie carbonated soft drinks
and certain non-carbonated beverages. Because we rely mainly on PepsiCo to provide us with the
products that we sell, if PepsiCo fails to develop innovative products that respond to these and other consumer
trends this could put us at a competitive disadvantage in the marketplace and adversely affect our
business and financial results.
We may not be able to respond successfully to the demands of our largest customers.
Our retail customers are consolidating, leaving fewer customers with greater overall
purchasing power. In addition, two of our customers together comprise approximately 10% of our
annual worldwide sales. Because we do not operate in all markets in which these customers operate,
we must rely on PepsiCo and other PepsiCo bottlers to service such customers outside of our
markets. Our inability, or the inability of PepsiCo and PepsiCo bottlers as a whole, to meet the
product, packaging and service demands of our largest customers could lead to a loss or decrease in
business from such customers and have a material adverse effect on our business and financial
results.
We may not be able to compete successfully within the highly competitive carbonated and
non-carbonated beverage markets.
The carbonated and non-carbonated beverage markets are both highly competitive. Competitive
pressures in our markets could cause us to reduce prices or forego price increases required to
off-set increased costs of raw materials and fuel, increase capital and other expenditures, or lose
market share, any of which could have a material adverse effect on our business and financial
results.
Because we depend upon PepsiCo to provide us with concentrate, certain funding and various
services, changes in our relationship with PepsiCo could adversely affect our business and
financial results.
We conduct our business primarily under beverage agreements with PepsiCo. If our beverage
agreements with PepsiCo are terminated for any reason, it would have a material adverse effect on
our business and financial results. These agreements provide that we must purchase all of the
concentrate for such beverages at prices and on other terms which are set by PepsiCo in its sole
discretion. Any significant concentrate price increases could materially affect our business and
financial results.
PepsiCo has also traditionally provided bottler incentives and funding to its bottling
operations. PepsiCo does not have to maintain or continue these incentives or funding.
Termination or decreases in bottler incentives or funding levels could materially affect our
business and financial results.
Under our shared services agreement, we obtain various services from PepsiCo, including
procurement of raw materials and certain administrative services. If any of the services under the
shared services agreement was terminated, we would have to obtain such services on our own. This
could result in a disruption of such services, and we might not be able to obtain these services on
terms, including cost, that are as favorable as those we receive through PepsiCo.
Our business requires a significant supply of raw materials, the limited availability or increased
costs of which could adversely affect our business and financial results.
The production of our beverage products is highly dependent on certain raw materials. In
particular, we require significant amounts of aluminum and plastic bottle components, such as
resin. We
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also require access to significant amounts of water. Any sustained interruption in the supply
of raw materials or any significant increase in their prices could have a material adverse effect
on our business and financial results.
PepsiCo’s equity ownership of PBG could affect matters concerning us.
As of January 27, 2006, PepsiCo owned approximately 46.9% of the combined voting power of our
voting stock (with the balance owned by the public). PepsiCo will be able to significantly affect
the outcome of PBG’s stockholder votes, thereby affecting matters concerning us.
We may have potential conflicts of interest with PepsiCo, which could result in PepsiCo’s
objectives being favored over our objectives.
Our past and ongoing relationship with PepsiCo could give rise to conflicts of interests. In
addition, two members of our Board of Directors and one of the three Managing Members of Bottling
Group LLC, our primary operating subsidiary, are Senior Vice Presidents of PepsiCo, a situation
which may create conflicts of interest.
These potential conflicts include balancing the objectives of increasing sales volume of
PepsiCo beverages and maintaining or increasing our profitability. Other possible conflicts could
relate to the nature, quality and pricing of services or products provided to us by PepsiCo or by
us to PepsiCo.
Conflicts could also arise in the context of our potential acquisition of bottling territories
and/or assets from PepsiCo or other independent PepsiCo bottlers. Under our Master Bottling
Agreement, we must obtain PepsiCo’s approval to acquire any independent PepsiCo bottler. PepsiCo
has agreed not to withhold approval for any acquisition within agreed upon U.S. territories if we
have successfully negotiated the acquisition and, in PepsiCo’s reasonable judgment, satisfactorily
performed our obligations under the master bottling agreement. We have agreed not to attempt to
acquire any independent PepsiCo bottler outside of those agreed-upon territories without PepsiCo’s
prior written approval.
Our acquisition strategy may be limited by our ability to successfully integrate acquired
businesses into ours or our failure to realize our expected return on acquired businesses.
We intend to continue to pursue acquisitions of bottling assets and territories from PepsiCo’s
independent bottlers. The success of our acquisition strategy may be limited because of unforeseen
costs and complexities. We may not be able to acquire, integrate successfully or manage profitably
additional businesses without substantial costs, delays or other difficulties. Unforeseen costs
and complexities may also prevent us from realizing our expected rate of return on an acquired
business. Any of the foregoing could have a material adverse effect on our business and financial
results.
Our success depends on key members of our management, the loss of whom could disrupt our business
operations.
Our success depends largely on the efforts and abilities of key management employees. Key
management employees are not parties to employment agreements with us. The loss of the services of
key personnel could have a material adverse effect on our business and financial results.
If we are unable to fund our substantial capital requirements, it could cause us to reduce our
planned capital expenditures and could result in a material adverse effect on our business and
financial results.
We require substantial capital expenditures to implement our business plans. If we do not
have sufficient funds or if we are unable to obtain financing in the amounts desired or on
acceptable terms, we may have to reduce our planned capital expenditures, which could have a
material adverse effect on our business and financial results.
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Our substantial indebtedness could adversely affect our financial health.
We have a substantial amount of indebtedness, which requires us to dedicate a substantial
portion of our cash flow from operations to payments on our debt. This could limit our flexibility
in planning for, or reacting to, changes in our business and place us at a competitive disadvantage
compared to competitors that have less debt. Our indebtedness also exposes us to interest rate
fluctuations, because the interest on some of our indebtedness is at variable rates, and makes us
vulnerable to general adverse economic and industry conditions. All of the above could make it
more difficult for us, or make us unable, to satisfy our obligations with respect to all or a
portion of such indebtedness and could limit our ability to obtain additional financing for future
working capital expenditures, strategic acquisitions and other general corporate requirements.
Our foreign operations are subject to social, political and economic risks and may be adversely
affected by foreign currency fluctuations.
In the fiscal year ended December 31, 2005, approximately 29% of our net revenues were
generated in territories outside the United States. Social, economic and political conditions in
our international markets may adversely affect our business and financial results. The overall
risks to our international businesses include changes in foreign governmental policies and other
political or economic developments. These developments may lead to new product pricing, tax or
other policies and monetary fluctuations which may adversely impact our business and financial
results. In addition, our results of operations and the value of our foreign assets are affected
by fluctuations in foreign currency exchange rates.
We may incur material losses and costs as a result of product liability claims that may be brought
against us or any product recalls we have to make.
We may be liable if the consumption of any of our products causes injury or illness. We also
may be required to recall products if they become contaminated or are damaged or mislabeled. A
significant product liability or other product related legal judgment against us or a widespread
recall of our products could have a material adverse effect on our business and financial results.
Newly adopted governmental regulations could increase our costs or liabilities or impact the sale
of our products.
Our operations and properties are subject to regulation by various federal, state and local
government entities and agencies as well as foreign governmental entities. Such regulations relate
to, among other things, food and drug laws, environmental laws, competition laws, taxes, and
accounting standards. We cannot assure you that we have been or will at all times be in compliance
with all regulatory requirements or that we will not incur material costs or liabilities in
connection with existing or new regulatory requirements.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
As of December 31, 2005, we operated 95 soft drink production facilities worldwide, of which
86 were owned and 7 were leased. In addition, one facility used for the manufacture of soft drink
packaging materials was operated by a PBG joint venture in Turkey and one facility used for can
manufacturing was operated by a PBG joint venture in Ayer, Massachusetts. Of our 546 distribution
facilities, 335 are owned and 211 are leased. We believe that our bottling, canning and syrup
filling lines and our distribution facilities are sufficient to meet present needs. We also lease
headquarters office space in Somers, New York.
We also own or lease and operate approximately 41,000 vehicles, including delivery trucks,
delivery and transport tractors and trailers and other trucks and vans used in the sale and
distribution of our
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soft drink products. We also own more than 2 million coolers, soft drink dispensing fountains and
vending machines.
With a few exceptions, leases of plants in the United States and Canada are on a long-term
basis, expiring at various times, with options to renew for additional periods. Most international
plants are leased for varying and usually shorter periods, with or without renewal options. We
believe that our properties are in good operating condition and are adequate to serve our current
operational needs.
Item 3. Legal Proceedings
From time to time we are a party to various litigation proceedings arising in the ordinary
course of our business, none of which, in the opinion of management, is likely to have a material
adverse effect on our financial condition or results of operations, including the following
proceeding:
At the end of the fourth quarter of 2004 and during the first three quarters of 2005, we
received Notices of Violation (“NOVs”) and Orders For Compliance from the Environmental Protection
Agency, Region 9 (“EPA”), relating to operations at four bottling plants in California and one in
Hawaii. The NOVs allege that we violated our permits and the Clean Water Act as a result of
certain events relating to waste water discharge and storm water run-off.
We have been cooperating with the authorities in their investigation of these matters,
including responding to various document requests pertaining to our plants in California and each
of our plants in Arizona and Hawaii. In August 2005, we met with representatives of the EPA to
discuss the circumstances giving rise to the NOVs and our responses. We believe monetary sanctions
may be sought in connection with one or more of the NOVs. We further believe that neither the
sanctions nor the remediation costs associated with these NOVs will be material to the Company’s
results of operations or financial condition.
Item 4. Submission of Matters to a Vote of Shareholders
None.
Executive Officers of the Registrant
Executive officers are elected by our Board of Directors, and their terms of office continue
until the next annual meeting of the Board or until their successors are elected and have been
qualified. There are no family relationships among our executive officers.
Set forth below is information pertaining to our executive officers who held office as of
February 15, 2006:
John T. Cahill, 48, is our Chairman of the Board and Chief Executive Officer. He has been our
Chairman of the Board since January 2003 and Chief Executive Officer since September 2001.
Previously, Mr. Cahill served as our President and Chief Operating Officer from August 2000 to
September 2001. Mr. Cahill has been a member of our Board of Directors since January 1999 and
served as our Executive Vice President and Chief Financial Officer prior to becoming President and
Chief Operating Officer in August 2000. He was Executive Vice President and Chief Financial
Officer of the Pepsi-Cola Company from April 1998 until November 1998. Prior to that, Mr. Cahill
was Senior Vice President and Treasurer of PepsiCo, having been appointed to that position in April
1997. In 1996, he became Senior Vice President and Chief Financial Officer of Pepsi-Cola North
America. Mr. Cahill joined PepsiCo in 1989 where he held several other senior financial positions
through 1996. Mr. Cahill is also a director of the Colgate-Palmolive Company.
Alfred H. Drewes, 50, is our Senior Vice President and Chief Financial Officer. Appointed to this
position in June 2001, Mr. Drewes previously served as Senior Vice President and Chief Financial
Officer of Pepsi-Cola International (“PCI”). Mr. Drewes joined PepsiCo in 1982 as a financial
analyst in New
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Jersey. During the next nine years, he rose through increasingly responsible finance positions
within Pepsi-Cola North America in field operations and headquarters. In 1991, Mr. Drewes joined
PCI as Vice President of Manufacturing Operations, with responsibility for the global concentrate
supply organization. In 1994, he was appointed Vice President of Business Planning and New Business
Development and, in 1996, relocated to London as the Vice President and Chief Financial Officer of
the Europe and Sub-Saharan Africa Business Unit of PCI.
Eric J. Foss, 47, is our Chief Operating Officer. Previously, Mr. Foss was President of PBG North
America from September 2001 to September 2005. Prior to that, Mr. Foss was the Executive Vice
President and General Manager of PBG North America from August 2000 to September 2001. From
October 1999 until August 2000, he served as our Senior Vice President, U.S. Sales and Field
Operations, and prior to that, he was our Senior Vice President, Sales and Field Marketing, since
March 1999. Mr. Foss joined Pepsi-Cola Company in 1982 and has held a variety of other field and
headquarters-based sales, marketing and general management positions. From 1994 to 1996, Mr. Foss
was General Manager of Pepsi-Cola North America’s Great West Business Unit. In 1996, Mr. Foss was
named General Manager for the Central Europe Region for Pepsi-Cola International, a position he
held until joining PBG in March 1999. Mr. Foss is also a director of United Dominion Realty Trust,
Inc.
Yiannis Petrides, 47, is the President of PBG Europe. He was appointed to this position in June
2000, with responsibilities for our operations in Spain, Greece, Turkey and Russia. Prior to that,
Mr. Petrides served as Business Unit General Manager for PBG in Spain and Greece. Mr. Petrides
joined PepsiCo in 1987 in the international beverage division. In 1993, he was named General
Manager of Frito Lay’s Greek operation with additional responsibility for the Balkan countries. In
1995, Mr. Petrides was appointed Business Unit General Manager for Pepsi Beverages International’s
bottling operation in Spain.
Steven M. Rapp, 52, is our Senior Vice President, General Counsel and Secretary. Appointed to this
position in January 2005, Mr. Rapp previously served as Vice President, Deputy General Counsel and
Assistant Secretary from 1999 through 2004. Mr. Rapp joined PepsiCo as a corporate attorney in
1986 and was appointed Division Counsel of Pepsi-Cola Company in 1994.
Rogelio Rebolledo, 61, was appointed President and Chief Executive Officer of PBG Mexico in January
2004 and elected to PBG’s Board in May 2004. From 2000 to 2003, Mr. Rebolledo was President and
Chief Executive Officer of Frito-Lay International (“FLI”), a subsidiary of PepsiCo, Inc.,
operating in Latin America, Asia Pacific, Australia, Europe, Middle East and Africa. From 1997 to
2000, Mr. Rebolledo was the President of the Latin America/Asia Pacific region for FLI. Mr.
Rebolledo joined PepsiCo, Inc. in 1976 and held several senior positions including serving as
President and Chief Executive Officer of the Latin America Region of PepsiCo Foods International
(“PFI”) and President of the Sabritas, Gamesa, Brazil and Spain PFI operations. Mr. Rebolledo was
elected to serve as a director of Appleby’s International, Inc. beginning in May 2006.
Gary K. Wandschneider, 53, was appointed Executive Vice President, Worldwide Operations in
September 2005. Prior to that, Mr. Wandschneider was our Senior Vice President of Operations, a
position he held since 1997. From 1994 to 1997, Mr. Wandschneider served as Vice President of
Manufacturing and Logistics. In 1992, he was appointed General Manager for PBG’s Texoma Business
Unit. Mr. Wandschneider joined Pepsi-Cola North America in 1982 as a Production Manager. He worked
in a variety of manufacturing and operations jobs of increasing responsibility until 1990, when he
was named Vice President of Operations for Pepsi-Cola North America.
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities
Stock
Trading Symbol — PBG.
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Stock Exchange Listings — PBG’s Common Stock is listed on the New York Stock Exchange. Our
Class B common stock is not publicly traded.
Shareholders
— As of February 15, 2006, there were approximately
56,925 registered and
beneficial shareholders of Common Stock. PepsiCo is the holder of all of the outstanding shares of
Class B common stock.
Stock Prices — The high and low sales prices for a share of PBG Common Stock on the New York
Stock Exchange, as reported by Bloomberg Service, for each fiscal quarter of 2005 and 2004 were as
follows (in dollars):
Dividend Policy — Quarterly cash dividends are usually declared in January, March, July and
November and paid at the end of March, June, September and at the beginning of January. The
dividend record dates for 2006 are expected to be March 10, June 9, September 8 and December 8.
Cash Dividends Declared Per Share on Capital Stock:
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PBG Purchase of Equity Securities — In the fourth quarter of 2005, we repurchased
approximately 5 million shares of PBG Common Stock. Since the inception of our share repurchase
program in October 1999, approximately 101 million shares of PBG Common Stock have been
repurchased. Our share repurchases for the fourth quarter of 2005 are as follows:
Unless terminated by resolution of the PBG Board, each share repurchase program
expires when we have repurchased all shares authorized for repurchase
thereunder.
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Item 6. Selected Financial Data
SELECTED FINANCIAL AND OPERATING DATA
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S FINANCIAL REVIEW
Tabular dollars in millions, except per share data OVERVIEW
The Pepsi Bottling Group, Inc. (“PBG” or the “Company”) is the world’s largest manufacturer,
seller and distributor of Pepsi-Cola beverages. When used in these Consolidated Financial
Statements, “PBG,” “we,” “our” and “us” each refers to The Pepsi Bottling Group, Inc. and, where
appropriate, to Bottling Group, LLC, our principal operating subsidiary.
We have the exclusive right to manufacture, sell and distribute
Pepsi-Cola beverages in all or a portion of the U.S., Mexico, Canada and
Europe, which consists of operations in Spain, Greece, Russia and Turkey.
As shown in the graph below, the U.S. business is the dominant driver of
our results, generating 61% of our volume, 71% of our revenues and 83% of
our operating income.
PBG is the world’s largest manufacturer, seller and distributor of Pepsi-Cola beverages. The
beverages sold by us include Pepsi-Cola, Diet Pepsi, Mountain Dew,
Aquafina, Lipton Brisk, Sierra Mist, Diet Mountain Dew, Tropicana Juice Drinks, SoBe
and Starbucks Frappuccino. In addition to the foregoing, the beverages we sell
outside the U.S. include 7 UP, Kas, Aqua Minerale, Mirinda and Manzanita
Sol. In some of our territories, we have the right to manufacture, sell and distribute soft
drink products of companies other than PepsiCo, Inc. (“PepsiCo”), including Dr Pepper and
Squirt. We also have the right in some of our territories to manufacture, sell and
distribute beverages under trademarks that we own, including Electropura, EPura and
Garci Crespo.
Our products are sold in either a cold-drink or take-home format. Our cold-drink format
consists of cold products sold in the retail and foodservice channels, which carry the highest
profit margins on a per-case basis. Our take-home format consists of unchilled products that are
sold for at-home future consumption.
Physical cases represent the number of units that are actually produced, distributed and sold.
Each case of product as sold to our customers, regardless of package configuration, represents one
physical case. Our net price and gross margin on a per-case basis are impacted by how much we
charge for the product, the mix of brands and packages we sell, and the channels in which the
product is sold. For example, we realize a higher net revenue and gross margin per case on a
20-ounce chilled bottle sold in a convenience store than on a two-liter unchilled bottle sold in a
grocery store.
Our financial success is dependent on a number of factors, including: our strong partnership
with PepsiCo, the customer relationships we cultivate, the pricing we achieve in the marketplace,
our market execution, our ability to meet changing consumer preferences and the efficiency we
achieve in manufacturing and distributing our products. Key indicators of our financial success
are measured by the number of physical cases we sell, the net price and gross margin we achieve on
a per-case basis, and our overall cost productivity, reflecting how well we manage our raw
material, manufacturing, distribution and other overhead costs.
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The following discussion and analysis covers the key drivers behind our business performance
in 2005 and is categorized into the following sections:
The discussion and analysis throughout Management’s Financial Review should be read in
conjunction with the Consolidated Financial Statements and the related accompanying notes. The
preparation of our Consolidated Financial Statements in conformity with accounting principles
generally accepted in the United States of America (“U.S. GAAP”) requires us to make estimates and
assumptions that affect the reported amounts in our Consolidated Financial Statements and the
related accompanying notes, including various claims and contingencies related to lawsuits, taxes,
environmental and other matters arising out of the normal course of business. We use our best
judgment, based on the advice of external experts and our knowledge of existing facts and
circumstances and actions that we may undertake in the future, in determining the estimates that
affect our Consolidated Financial Statements.
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ITEMS THAT AFFECT HISTORICAL OR FUTURE COMPARABILITY
High
Fructose Corn Syrup (“HFCS”) Settlement
Included in our selling, delivery and administrative expenses for 2005 was a pre-tax gain of
$29 million in the U.S. from the settlement of the HFCS class action lawsuit. The lawsuit related
to purchases of high fructose corn syrup by several companies, including bottling entities owned
and operated by PepsiCo, during the period from July 1, 1991 to June 30, 1995 (the “Claims
Period”). Certain of the bottling entities owned by PepsiCo during the Claims Period were
transferred to PBG when PepsiCo formed PBG in 1999. With respect to these entities, which we
currently operate, we received $23 million in HFCS settlement proceeds. We received an additional
$6 million in HFCS settlement proceeds related to bottling operations not previously owned by
PepsiCo, such as manufacturing co-operatives of which we are a member.
53rd Week
Our fiscal year ends on the last Saturday in December and, as a result, a 53rd week
is added every five or six years. Fiscal year 2005 consisted of 53 weeks while fiscal years 2004
and 2003 consisted of 52 weeks. Our 2005 results included pre-tax income of approximately $19
million due to the 53rd week.
Strategic Spending Initiatives
We reinvested both the pre-tax gain of $29 million from the HFCS settlement and the pre-tax
income of $19 million from the 53rd week in long-term strategic spending initiatives in
the U.S., Canada and Europe. The strategic spending initiatives included programs designed
primarily to enhance our customer service agenda, drive productivity and improve our management
information systems. These strategic spending initiatives were recorded in selling, delivery and
administrative expenses.
Non-GAAP Measurements and Adjusted Results
We prepare our consolidated financial statements in conformity with U.S. GAAP. In an effort to provide investors with additional information
regarding the Company’s results we have included in this document certain
“non-GAAP” measures as defined by the Securities and Exchange Commission. Specifically, we
have presented “non-GAAP” measures to supplement our Financial Performance Summary and our 2006
Outlook. We have excluded the impact of the HFCS Settlement, the 53rd Week and the
Strategic Spending Initiatives from our 2005 results and from certain items in our 2006 Outlook as
we consider these items as unusual and outside of the ordinary course of our business. Management
believes these “non-GAAP” financial measures provide useful information to investors regarding the
underlying business performance of the Company’s ongoing results and should be considered in
addition to, not
in lieu of, U.S. GAAP reported measures. “Non-GAAP” measures used in this document are
referred to as “adjusted.”
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The tables below illustrate the approximate dollars and percentage points of operating income
growth that these unusual items contributed to our 2005 operating results.
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FINANCIAL PERFORMANCE SUMMARY
During 2005, we delivered strong results, reflecting robust topline growth which was partially
offset by higher raw material costs and selling, delivery and administrative expenses. Overall, we
grew our worldwide operating income by five percent, which includes a one percentage point benefit
from the net impact of the 53rd week, the gain from the HFCS settlement and spending
initiatives. These results were driven by operating income growth in the U.S. of six percent, of
which two percentage points were driven by the unusual items discussed above, coupled with
double-digit increases in Mexico and Canada. This growth was partially offset by a double-digit
operating income decrease in Europe, driven by declines in Spain. Our operating income growth in
Mexico, which includes the lapping of a $9 million impairment charge in 2004, was below our
expectations due mostly to lower than anticipated cost savings in our selling, delivery and
administrative expenses.
Our strong worldwide topline growth was driven by innovation, including new products, pricing
improvements and strong execution in the marketplace as well as the impact of the 53rd
week. Growth was driven primarily by an approximate three-percent increase in volume and a
three-percent increase in net revenue per case. The impact of the 53rd week, the effect
of foreign currency translation and acquisitions each contributed a percentage point to our topline
growth.
In the U.S., we achieved a five-percent volume increase, which includes three percentage
points of growth due to the 53rd week and acquisitions. The balance of the growth was
due primarily to volume increases in both large format stores and our foodservice business which
consists of restaurants and workplaces. These volume increases were driven by a three-percent
increase in our take-home channel and a two-percent increase in our cold-drink channel. Our
portfolio growth was in line with consumer trends, with most of the volume increase coming from our
water, non-carbonated and diet portfolios. In the U.S., net revenue per case increased three
percent, driven primarily by rate increases.
In Canada, topline growth of 14 percent was driven primarily by the favorable impact of
foreign currency translation, coupled with a net revenue per case increase of three percent and
volume improvements of two percent, as well as the 53rd week. Volume and pricing growth
was fueled by strong execution and strategic marketing programs that were designed to gain consumer
interest.
In Europe, we delivered strong topline results, growing net revenues by 12 percent
versus the prior year, driven by double-digit volume growth in Russia and Turkey.
Our Mexico topline growth of 10 percent was driven primarily by volume growth of five percent
and the favorable impact of foreign currency translation. Our volume growth in Mexico was fueled
by double-digit increases in both our bottled water and jug businesses, partially offset by slight
declines in our carbonated soft drink business.
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Our strong worldwide topline growth was partially offset by increases in cost of sales, which
have continued to pressure our bottom line results. On a per-case basis, cost of sales increased
five percent, reflecting significant increases in raw material costs. During 2005, we continued to
see increases in resin prices, exacerbated by a severe hurricane season in the U.S. These increases
added approximately $100 million of costs or approximately two percentage points of growth to our
worldwide cost of sales per case. Additionally, the negative impact of foreign currency
translation contributed one percentage point of growth to our cost of
sales per case increase.
Worldwide selling, delivery and administrative expenses increased eight percent. Increases in
selling, delivery and administrative costs were driven by higher volume growth, wage and benefit
increases and rising fuel prices. Additionally, the strategic spending initiatives and the
additional expenses from the 53rd week, partially offset by the gain from the settlement
of the HFCS class action lawsuit, added approximately one percentage point of growth to our overall
selling, delivery and administrative expenses. The strategic spending initiatives included
programs to implement our new customer service program, drive productivity and improve our
management information systems.
Interest expense, net increased by $20 million due to the impact of rising interest rates on
approximately 26 percent of our debt that is variable, coupled with the impact of the
53rd week.
The Company’s cash flow from operations continued to be strong in 2005. We generated $1.2
billion of cash from operations, after contributing $77 million into our pension plans, which are
adequately funded. With our strong cash flows, we utilized $715 million for capital investments to
grow our business and returned $554 million to our shareholders through share repurchases and
dividends during the year. During 2005, we increased our annual dividend by 60 percent, raising it
from $0.20 to $0.32 per share.
2006 Outlook
In 2006, our fiscal year will consist of 52 weeks, while fiscal year 2005 consisted of 53
weeks. Our U.S. and Canadian operations report on a fiscal year that consists of 52 weeks, ending
on the last Saturday in December. Every five or six years a 53rd week is added. Our
other countries report on a calendar-year basis.
Our
2005 results included the impact of the
53rd
week. In order to provide comparable guidance for 2006, we have
excluded the impact of the 53rd
week from our volume outlook,
as described in the table below.
As discussed in Note 2 in the Notes to the Consolidated Financial Statements, the Company will
adopt Statement of Financial Accounting Standards No. 123
(revised 2004), “Share-Based Payment” (“SFAS 123R”) in
the first quarter of 2006. SFAS 123R will require that all stock-based payments be expensed based on the fair value of the awards. In accordance
with existing accounting guidelines, the Company did not recognize compensation expense for stock
options during fiscal year 2005. Therefore, management believes that
providing an adjusted measure
that excludes the impact of SFAS 123R from the 2006 Outlook provides a meaningful year-over-year
comparison of SD&A, operating income change and diluted earnings per share. The tables below
provide an adjusted forecast by excluding, where applicable, the
impact of the 53rd
week and
the impact of the adoption of SFAS 123R in 2006:
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In
2006, we will carefully balance our net revenue per case, using rate increases where
marketplace conditions allow, while also managing the mix of products we plan to sell. We expect
to increase both our worldwide and U.S. net revenue per case two to three percent, driven primarily
by rate improvements, coupled with a mix shift into higher-priced products.
In 2006, worldwide cost of sales per case is expected to increase by approximately three
percent. We are expecting the rate of growth of our raw material costs, particularly resin and
sweeteners, to moderate during 2006. Nonetheless we anticipate that our raw material costs,
including aluminum, resin and sweeteners will increase in the low single digits in 2006. As a
result, we expect our gross margin per case to grow about two percent.
Our selling, delivery and
administrative expenses are expected to rise approximately four to five percent, including
increases in fuel cost and higher pension expense, each contributing approximately $20 million of
additional expense. The impact of adopting SFAS 123R will add approximately $70 million to our
overall SD&A and result in a seven percentage point reduction in our operating income.
Accordingly, we expect our operating income to be down two to four percent for the year.
In 2006, we expect interest expense to increase to approximately $270 million, reflecting the
impact of rising interest rates on approximately 26 percent of our debt that is variable, coupled
with increased interest associated with anticipated debt financings in 2006.
From a cash flow perspective, we expect to generate net cash provided by operations of over
$1.2 billion and we plan to spend approximately $735 million in capital investments. Net cash
provided by operations less capital expenditures is expected to be $500 to $520 million in 2006.
Our cash flows from
operations in 2006 are expected to increase versus 2005 due to lower pension contributions and
a greater mix of non-cash charges in 2006.
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CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements in conformity with U.S. GAAP often
requires us to make judgments, estimates, and assumptions regarding uncertainties that affect the
results of operations, financial position and cash flows of the Company, as well as the related
footnote disclosures. Management bases its estimates on knowledge of our operations, markets in
which we operate, historical trends, and other assumptions. Actual results could differ from these
estimates under different assumptions or conditions. Significant accounting policies are discussed
in the Notes to the Consolidated Financial Statements. Our critical accounting policies are those
policies which management believes are most important to the portrayal of PBG’s financial condition
and results of operations and require the use of estimates, assumptions and the application of
judgment. Management has reviewed these critical accounting policies and related disclosures with
the Audit and Affiliated Transactions Committee of our Board of Directors.
Allowance
for Doubtful Accounts — A portion of our accounts receivable will not be collected
due to bankruptcies and sales returns. Estimating an allowance for doubtful accounts requires
significant management judgment and assumptions regarding the potential for losses on receivable
balances.
Our accounting policy for the provision for doubtful accounts requires reserving an amount
based on the evaluation of the aging of accounts receivable, sales return trend analysis, detailed
analysis of high-risk customer accounts, and the overall market and economic conditions of our
customers. Accordingly, we estimate the amounts necessary to provide for losses on receivables by
using quantitative measures, evaluating specific customer accounts for risk of loss, and adjusting
for changes in economic conditions in which we and our customers operate.
We manage the risk of losses on accounts receivable by having effective credit controls and by
evaluating our receivables on an ongoing basis. Our allowance for doubtful accounts represents
management’s best estimate of probable losses inherent in our portfolio. If a general economic
downturn occurs causing the financial condition of our customers to deteriorate or if one of our
customers has an
unforeseen inability to pay us, the allowance for doubtful accounts and bad debt expense would
be increased from our estimate.
The following is an analysis of the allowance for doubtful accounts for the fiscal years ended
December 31, 2005, December 25, 2004 and December 27, 2003:
Recoverability
of Goodwill and Intangible Assets with Indefinite Lives — Goodwill and
intangible assets with indefinite useful lives are not amortized, but instead tested annually for
impairment.
Our identified intangible assets principally arise from the allocation of the purchase price
of businesses acquired, and consist primarily of franchise rights, distribution rights and brands.
We assign amounts to such identified intangibles based on their estimated fair values at the date
of acquisition. The determination of the expected life will be dependent upon the use and
underlying characteristics of the identified intangible asset. In determining whether our
intangible assets have an indefinite useful life, we consider the following as applicable: the
nature and terms of underlying agreements; our intent and ability to use the specific asset
contained in an agreement; the age and market position of the products within the territories we
are entitled to sell; the historical and projected growth of those products; and costs, if any, to
renew the agreement.
We evaluate our identified intangible assets with indefinite useful lives for impairment
annually (unless it is required more frequently because of a triggering event). We measure impairment as the amount by which the carrying value exceeds its estimated fair
value.
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The fair value of our franchise rights and distribution rights is measured using a
multi-period excess earnings method that is based upon estimated discounted future cash flows. We
deduct a contributory charge from our net after-tax cash flows for the economic return attributable
to our working capital, other intangible assets and property, plant and equipment, which represents
the required cash flow to support these assets. The net discounted cash flows in excess of the
fair returns on these assets represent the estimated fair value of our franchise rights and
distribution rights.
The fair value of our brands is measured using a multi-period royalty savings method, which
reflects the savings realized by owning the brand and, therefore, not having to pay a royalty fee
to a third party. In valuing our brands, we have selected an estimated industry royalty rate
relating to each brand and then applied it to the forecasted revenues associated with each brand.
The net discounted after-tax cash flows from these royalty charges represent the fair value of our
brands.
Our discount rate utilized in each fair value calculation is based upon our weighted-average
cost of capital plus an additional risk premium to reflect the risk and uncertainty inherent in
separately acquiring the identified intangible asset between a willing buyer and a willing seller.
The additional risk premium associated with our discount rate effectively eliminates the benefit
that we believe results from synergies, scale and our assembled workforce, all of which are
components of goodwill. Each year we re-evaluate our assumptions in our discounted cash flow model
to address changes in our business and marketplace conditions.
We evaluate goodwill on a country-by-country basis (“reporting unit”) for impairment. We
evaluate each reporting unit for impairment based upon a two-step approach. First, we compare the
fair value of our reporting unit with its carrying value. Second, if the carrying value of our
reporting unit exceeds its fair
value, we compare the implied fair value of the reporting unit’s goodwill to its carrying
amount to measure the amount of impairment loss. In measuring the implied fair value of goodwill,
we would allocate the fair value of the reporting unit to each of its assets and liabilities
(including any unrecognized intangible assets). Any excess of the fair value of the reporting
unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.
We measure the fair value of a reporting unit as the discounted estimated future cash flows,
including a terminal value, which assumes the business continues in perpetuity, less its respective
minority interest and net debt (net of cash and cash equivalents). Our long-term terminal growth
assumptions reflect our current long-term view of the marketplace. Our discount rate is based upon
our weighted-average cost of capital for each reporting unit. Each year we re-evaluate our
assumptions in our discounted cash flow model to address changes in our business and marketplace
conditions.
Considerable management judgment is necessary to estimate discounted future cash flows in
conducting an impairment test for goodwill and other identified intangible assets, which may be
impacted by future actions taken by us and our competitors and the volatility in the markets in
which we conduct business. A change in assumptions in our cash flows could have a significant
impact on the fair value of our reporting units and other identified intangible assets, which could
then result in a material impairment charge to our results of operations. For example, an
inability to achieve strategic business plan targets in a reporting unit could result in an
impairment charge of one or more specific intangible assets. In
Mexico, we have recorded
approximately $1 billion of intangible assets. Mexico has not met our profit expectations;
however, we have specific plans in place to improve our future results. We will continue to
closely monitor our performance in Mexico and evaluate the realizability of each intangible asset.
Pension
and Postretirement Medical Benefit Plans — We sponsor pension and other postretirement
medical benefit plans in various forms, covering employees who meet specified eligibility
requirements.
Our U.S. employees participate in noncontributory defined benefit pension plans, which cover
substantially all full-time salaried employees, as well as most hourly employees. Our net pension
expense for the defined benefit plans for our operations outside the U.S. was not significant, and
accordingly assumptions and sensitivity analyses regarding these plans are not included in the
discussion below.
Assumptions and estimates are required to calculate the expenses and obligations for these
plans including discount rate, expected return on plan assets, retirement age, mortality, turnover,
health care cost trend rates and compensation rate increases.
We evaluate these assumptions with our actuarial advisors on an annual basis and we believe
that they are appropriate. Our assumptions are based upon historical experience of the plan and
expectations for the future. These assumptions may differ materially from actual results due to
changing market and economic conditions. An increase
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or decrease in the assumptions or economic
events outside our control could have a material impact on reported net income and the related
funding requirements.
Key Assumptions
The assets, liabilities and assumptions used to measure pension and postretirement medical
expense for any fiscal year are determined as of September 30th of the preceding year
(“measurement date”).
The discount rate assumption is derived from the present value of our expected pension and
postretirement medical benefit payment streams. The present value is calculated by utilizing a
yield curve that matches the timing of our expected benefit payments. The yield curve is developed
by our actuarial advisers using a portfolio of several hundred high quality non-callable corporate
bonds. The bonds are rated Aa or better by Moody’s and have at least $250 million in principal
amount. The bonds are denominated in U.S. dollars and have maturity dates ranging from six months
to thirty years. Once the present value of all the expected payment streams has been calculated, a
single discount rate is determined. The weighted-average discount rate for fiscal year 2006 for our
pension and postretirement medical plans is 5.80 percent and 5.55 percent, respectively.
In evaluating the expected rate of return on assets for a given fiscal year, we consider both
projected future returns of asset classes and the actual 10 to 15-year historic returns on asset
classes in our pension investment portfolio, reflecting the weighted-average return of our asset
allocation. Our target asset allocation for our domestic pension assets is 75 percent equity
investments, of which approximately 80 percent is invested in domestic equities and 20 percent is
invested in foreign equities. The remaining 25 percent of our plan assets is invested primarily in
fixed income securities, which is equally divided between
U.S. government and corporate bonds. Our current portfolio’s target asset allocation for the
10 and 15-year periods had weighted average returns of 8.80 percent and 10.80 percent,
respectively. Over time, the expected rate of return on pension plan assets should approximate the
actual long-term returns. Based on the historic and estimated future returns of our portfolio, we
estimate the long-term rate of return on assets for our domestic pension plans to be 8.50 percent
in 2006.
Pension and Postretirement Medical Plans Accounting
Differences between actual and expected returns on plan assets are recognized in the net
periodic pension calculation over five years. To the extent the amount of all unrecognized gains
and losses exceeds 10 percent of the larger of the benefit obligation or plan assets, such amount
is amortized over the average remaining service period of active participants. Net unrecognized
losses, within our pension and postretirement plans totaled $611 million and $603 million at
December 31, 2005 and December 25, 2004, respectively.
The following table provides our current and expected weighted-average assumptions for our
pension and postretirement medical plans’ expense in the United States:
During 2005, our Company-sponsored defined benefit pension and postretirement medical plan
expenses in the U.S. totaled $109 million, including a special termination benefit charge of $9
million for a voluntary early retirement enhancement program. In 2005, our ongoing pension and
postretirement medical plan expenses, excluding the special termination benefit charge, were $100
million. In 2006, our ongoing expenses will increase by approximately $19 million to $119 million
due primarily to the following factors:
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Sensitivity Analysis
It is unlikely that in any given year the actual rate of return will be the same as the
assumed long-term rate of return of 8.50 percent. The following table provides a summary of the
last three years of actual returns versus the expected long-term returns for our domestic pension
plans:
Sensitivity of changes in key assumptions for our principal pension and postretirement plans’
expense in 2006 are as follows:
For further information about our pension and postretirement plans see Note 12 in the Notes to
Consolidated Financial Statements.
Casualty
Insurance Costs — Due to the nature of our business, we require insurance coverage
for certain casualty risks. In the United States we are self-insured for workers’ compensation and
automobile risks for occurrences up to $10 million, and product and general liability risks for
occurrences up to $5 million. For losses exceeding these self-insurance thresholds, we purchase
casualty insurance from a third-party provider.
Our liability for casualty costs of $188 million and $169 million as of December 31, 2005 and
December 25, 2004, respectively, is estimated using individual case-based valuations and
statistical analyses and is based upon historical experience, actuarial assumptions and
professional judgment. We do not discount our loss expense reserves. These estimates are subject to
the effects of trends in loss severity and frequency and are subject to a significant degree of
inherent variability. We evaluate these estimates with our actuarial advisors periodically during
the year and we believe that they are appropriate, although an increase or decrease in the
estimates or events outside our control could have a material impact on reported net income.
Accordingly, the ultimate settlement of these costs may vary significantly from the estimates
included in our financial statements.
Income
Taxes — Our effective tax rate is based on pre-tax income, statutory tax rates, tax
regulations and tax planning strategies available to us in the various jurisdictions in which we
operate. The tax bases of our assets and liabilities reflect our best estimate of the tax benefits
and costs we expect to realize. We establish valuation allowances to reduce our deferred tax
assets to an amount that will more likely than not be realized. A significant portion of deferred
tax assets consists of net operating loss carryforwards (“NOLs”). We have NOLs totaling $1,146
million at December 31, 2005, which are available to reduce future taxes in the U.S., Spain,
Greece, Russia, Turkey and Mexico. The majority of our NOLs are generated overseas, the largest of
which is coming from our Mexican and Spanish operations. Of these NOLs, $6 million expire in 2006
and $1,140 million expire at various times between 2007 and 2025.
Significant management judgment is required in determining our effective tax rate and in
evaluating our tax position. We establish reserves when, based on the applicable tax law and facts
and circumstances relating to a
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particular
transaction or tax position, it becomes probable
that the position will not be sustained when challenged by a taxing authority. A change in our tax
reserves could have a significant impact on our results of operations.
Under our tax separation agreement with PepsiCo, PepsiCo maintains full control and absolute
discretion for any combined or consolidated tax filings for tax periods ended on or before our
initial public offering that occurred in March 1999. However, PepsiCo may not settle any issue
without our written consent, which consent cannot be unreasonably withheld. PepsiCo has
contractually agreed to act in good faith with respect to all tax examination matters affecting us.
In accordance with the tax separation agreement, we will bear our allocable share of any risk or
benefit resulting from the settlement of tax matters affecting us for these tax periods.
A number of years may elapse before a particular matter for which we have established a tax
contingency reserve is audited and finally resolved. The number of years for which we have audits
that are open varies depending on the tax jurisdiction. The U.S. Internal Revenue Service (“IRS”)
is currently examining our and PepsiCo’s joint tax returns for 1998 through March 1999 and our tax
returns for the 2001 and 2002 tax years. The IRS audit of our 1999 and 2000 tax returns concluded
in 2005. However, pursuant to an agreement with the IRS, our 1999 and 2000 tax years remain open
solely with respect to matters arising out of the IRS examination of PepsiCo involving our initial
public offering transaction on March 31, 1999. While it is often difficult to predict the final
outcome or the timing of the resolution, we believe that our tax reserves reflect the probable
outcome of known tax contingencies. Favorable resolutions would be recognized as a reduction of our
tax expense in the year of resolution. Unfavorable resolutions would be recognized as a reduction
to our reserves, a cash outlay for settlement and a possible increase to our annual tax provision.
For further information about our income taxes see Note 14 in the Notes to Consolidated Financial
Statements.
RELATED PARTY TRANSACTIONS
PepsiCo is considered a related party due to the nature of our franchise relationship and its
ownership interest in our company. More than 80 percent of our volume is derived from the sale of
brands from PepsiCo. At December 31, 2005, PepsiCo owned approximately 41.2 percent of our
outstanding common stock and 100 percent of our outstanding class B common stock, together
representing approximately 46.8 percent of the voting power of all classes of our voting stock. In
addition, PepsiCo owns 6.7 percent of the equity of Bottling Group, LLC, our principal operating
subsidiary. We fully consolidate the results of Bottling Group, LLC and present PepsiCo’s share as
minority interest in our Consolidated Financial Statements.
Our business is conducted primarily under beverage agreements with PepsiCo, including a master
bottling agreement, a non-cola bottling agreement and a master syrup agreement. Additionally,
under a shared services agreement, we obtain various services from PepsiCo, which include services
for information technology maintenance and the procurement of raw materials. We also provide
services to PepsiCo, including facility and credit and collection support.
We review our annual marketing, advertising, management and financial plans each year with
PepsiCo for its approval. If we fail to submit these plans, or if we fail to carry them out in all
material respects, PepsiCo can terminate our beverage agreements. Because we depend on PepsiCo to
provide us with concentrate, bottler incentives and various services, changes in our relationship
with PepsiCo could have a material adverse effect on our business and financial results.
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The Consolidated Statements of Operations include the following income (expense) amounts
as a result of transactions with PepsiCo and its affiliates:
(a) Bottler Incentives and Other Arrangements — In order to promote PepsiCo beverages,
PepsiCo, at their sole discretion, provides us with various forms of bottler incentives. These
incentives cover a variety of initiatives, including direct marketplace support and advertising
support. We record most of these incentives as an adjustment to cost of sales unless the incentive
is for reimbursement of a specific, incremental and identifiable cost. Under these conditions, the
incentive would be recorded as an offset against the related costs, either in revenue or selling,
delivery and administrative expenses. Changes in our bottler incentives and funding levels could
materially affect our business and financial results.
(b) Purchase of Concentrate and Finished Product — As part of our franchise relationship, we
purchase concentrate from PepsiCo, pay royalties and produce or distribute other products through
various arrangements with PepsiCo or PepsiCo joint ventures. The prices we pay for concentrate,
finished goods and royalties are determined by PepsiCo at its sole discretion. Concentrate prices
are typically determined annually. In February 2005, PepsiCo increased the price of U.S.
concentrate by two percent. PepsiCo has recently announced a further increase of approximately two
percent, effective February 2006. Significant changes in the amount we pay PepsiCo for
concentrate, finished goods and royalties could materially affect our business and financial
results. These amounts are reflected in cost of sales in our Consolidated Statements of Operations.
(c) Manufacturing
and Distribution Service Reimbursements — In 2003, we provided manufacturing
services to PepsiCo and PepsiCo affiliates in connection with the production of certain finished
beverage products.
(d) Fountain
Service Fee — We manufacture and distribute fountain products and provide
fountain equipment service to PepsiCo customers in some territories in accordance with the Pepsi
beverage agreements. Amounts received from PepsiCo for these transactions are offset by the cost
to provide these services and are reflected in our Consolidated Statements of Operations in
selling, delivery and administrative expenses.
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(e) Frito-Lay Purchases — We purchase snack food products from Frito-Lay, Inc., a subsidiary
of PepsiCo, for sale and distribution in Russia. Amounts paid to PepsiCo for these transactions are
reflected in selling, delivery and administrative expenses in our Consolidated Statements of
Operations.
(f) Shared
Services — We provide to and receive various services from PepsiCo and PepsiCo
affiliates pursuant to a shared services agreement and other arrangements. In the absence of
these agreements, we would have to obtain such services on our own. We might not be able to obtain
these services on terms, including cost, which are as favorable as those we receive from PepsiCo.
Total expenses incurred and income generated are reflected in selling, delivery and administrative
expenses in our Consolidated Statements of Operations.
(g) Income
Tax Benefit — Under our tax separation agreement with PepsiCo, PepsiCo maintains full
control and absolute discretion for any combined or consolidated tax filings for tax periods ended
on or before our initial public offering that occurred in March 1999. PepsiCo has contractually
agreed to act in good faith with respect to all tax examination matters affecting us. In
accordance with the tax separation agreement, we will bear our allocable share of any risk or
benefit resulting from the settlement of tax matters affecting us for these periods.
(h) High Fructose Corn Syrup (“HFCS”) Settlement — On June 28, 2005, Bottling Group, LLC and PepsiCo entered into a settlement agreement related
to the allocation of certain proceeds from the settlement of the HFCS class action lawsuit. The
lawsuit related to purchases of high fructose corn syrup by several companies, including bottling
entities owned and operated by PepsiCo, during the period from July 1, 1991 to June 30, 1995 (the
“Class Period”). Certain of the bottling entities owned by PepsiCo were transferred to PBG when
PepsiCo formed PBG in 1999 (the “PepsiCo Bottling Entities”). Under the settlement agreement with
PepsiCo, the Company ultimately received 45.8 percent (or approximately $23 million) of the total
recovery related to HFCS purchases by PepsiCo Bottling Entities during the Class Period.
As of December 31, 2005 and December 25, 2004, the receivables from PepsiCo and its affiliates
were $143 million and $150 million, respectively. These balances are shown as part of accounts
receivable in our Consolidated Financial Statements. The payables to PepsiCo and its affiliates
were $176 million and $144 million, respectively. These balances are shown as part of accounts
payable and other current liabilities in our Consolidated Financial Statements.
For further information about our relationship with PepsiCo and its affiliates see Note 16 in
Notes to Consolidated Financial Statements.
RESULTS
OF OPERATIONS — 2005
Volume
Our full-year reported worldwide physical case volume increased five percent in 2005 versus
2004. Worldwide volume growth reflects increases in all of PBG territories. PBG territories are
defined as U.S., Canada, Europe and Mexico.
In the U.S., increases in volume, excluding acquisitions and the impact of the 53rd
week, were driven by a three-percent increase in our take-home channel and a two-percent
increase in our cold-drink channel. These volume increases were attributable to solid results in
large format businesses and foodservice venues. In the U.S. our growth reflects consumer trends.
Our non-carbonated beverage volume increased 18 percent, led by
31-percent
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growth in Trademark Aquafina and the successful introduction of Aquafina
Flavor Splash, coupled with solid performance in Trademark Starbucks and in our
energy drinks. Our total carbonated soft drink portfolio was down about one percent,
mostly driven by declines in brand Pepsi, partially offset by the successful introduction
of Pepsi Lime,
double-digit growth in brand Wild Cherry Pepsi, and a three-percent increase in our diet portfolio.
In Canada, volume increased three percent in 2005 versus 2004, primarily driven by increases
in both the cold-drink and take-home channels. This growth was fueled by strong execution and
strategic marketing programs that were designed to gain consumer interest. The 53rd
week contributed approximately one percentage point of growth.
In Europe, volume grew eight percent in 2005 versus 2004, driven by double-digit increases in
Russia and Turkey. In Russia, we had solid growth in trademark Pepsi and Aqua
Minerale, coupled with strong growth in Tropicana Juice, Lipton Iced Tea and
local brands. In Turkey, we continued to improve our customer service through the consolidation of
3rd party distributors and the migration of selling activities to our own employees.
These improvements and an effective advertising campaign resulted in volume increases in brand
Pepsi and in local brands, such as Yedigun.
Total volume in Mexico was up five percent for the year, driven largely by growth in our water
business, including an 11 percent increase in our jug water business and a 13 percent increase in
our bottled water business. The investments that we began making in 2004 in the marketplace and in
our infrastructure in Mexico have enabled us to improve both our bottled water and jug water
businesses, including expansion of our home delivery system for jug water. Our carbonated soft
drink portfolio in Mexico was down about one percent primarily due to competitive pressure in the
Mexico City area. This decline was partially offset by solid performance in our carbonated soft
drink business outside the Mexico City area which accounts for 75 percent of our volume.
Net Revenues
Worldwide net revenues were $11.9 billion in 2005, a nine-percent increase over the prior
year. The increase in net revenues for the year was driven primarily by strong volume growth and
increases in net price per case, coupled with the favorable impact from currency translation in
Canada and Mexico, acquisitions and the impact of the 53rd week.
In the U.S., net revenues increased eight percent in 2005 versus 2004. The increases in net
revenues in the U.S. were driven primarily by increases in net price per case, solid growth in
volume, and the impact of the 53rd week. Additionally, acquisitions added one
percentage point of growth. Increases in net price per case in the U.S. were mostly due to rate
increases.
Net revenues outside the U.S. grew approximately 12 percent in 2005 versus 2004. The
increases in net revenues outside the U.S. were driven primarily by growth in volume and the
favorable impact of foreign exchange in Canada and Mexico, coupled with net price per case
increases in Europe and Canada.
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Cost of Sales
Worldwide cost of sales was $6.3 billion in 2005, an 11-percent increase over 2004. The
growth in cost of sales was driven primarily by volume and cost per case increases, coupled with
the negative impact of foreign currency translation in Canada and Mexico, acquisitions and the
impact of the 53rd week. During 2005, we continued to see increases in resin prices,
exacerbated by a severe hurricane season in the U.S. These increases added approximately $100
million of costs or approximately two percentage points of growth to our worldwide cost of sales
per case.
In the U.S., cost of sales grew nine percent in 2005 versus 2004, due to increases in cost per
case and volume growth, coupled with the impact of the 53rd week and acquisitions. The
increases in cost per case resulted from higher raw material costs, primarily driven by resin.
Cost of sales outside the U.S. grew approximately 14 percent in 2005 versus 2004, reflecting
strong volume growth and increases in cost per case, coupled with the negative impact from foreign
currency translation. Growth in cost per case resulted from higher raw material costs, primarily
driven by resin increases across all of our countries. Foreign currency translation contributed
four percentage points of growth, reflecting the appreciation of the Canadian dollar and Mexican
peso.
Selling, Delivery and Administrative Expenses
Worldwide selling, delivery and administrative expenses were $4.6 billion, an eight percent
increase over 2004. Increases in selling, delivery and administrative costs were driven by higher
volume growth, wage and benefit increases and rising fuel prices. The strategic spending
initiatives and the impact of the 53rd week in the U.S. and Canada, partially offset by
the pre-tax gain of $29 million in the U.S. from the settlement of the HFCS class action lawsuit
contributed approximately one percentage point of an increase in selling, delivery and
administrative expenses. PBG invested both the HFCS gain and the additional income from the
53rd week in long-term strategic spending initiatives which totaled $48 million. The
strategic spending initiatives included programs to enhance our customer service agenda, drive
productivity, including restructuring in Europe, and improve our management information systems.
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In the U.S., increases reflected higher volume growth, wage and benefit increases, additional
expenses from the 53rd week and rising fuel prices, partially offset by the gain from
settlement of the HFCS class action lawsuit. In addition, the strategic spending initiatives
contributed more than one percentage point of growth to our increase in selling, delivery and
administrative expenses for the year.
Outside the U.S., increases were driven primarily by volume growth, wage and benefit
increases, and the negative impact of foreign currency translation in Canada and Mexico, coupled
with strategic spending initiatives. These increases were partially offset by the lapping of a $9
million non-cash impairment charge taken for the franchise licensing agreement associated with the
Squirt trademark in Mexico in the prior year. Our selling, delivery and administrative expenses in
Mexico were higher than expected as certain of the cost savings initiatives have not yielded
expected results.
Net Interest Expense
Net interest expense increased by $20 million, when compared with 2004, largely due to higher
effective interest rates from interest rate swaps, which convert our fixed-rate debt to variable
debt, coupled with the impact of the 53rd week of approximately $5 million. As of
December 31, 2005 approximately 26 percent of our long-term debt was variable.
Minority Interest
Minority interest represents PepsiCo’s approximate 6.7 percent and 6.8 percent ownership in
our principal operating subsidiary, Bottling Group, LLC for the years ended 2005 and 2004,
respectively.
Income Tax Expense
Our effective tax rates for 2005 and 2004 were 34.7 percent and 33.7 percent, respectively.
The increase in our 2005 effective tax rate versus the prior year is mainly due to higher earnings
in the U.S. and increased tax contingencies related to certain historic tax positions and resulting
from changes in our international legal entity and debt structure. These increases in our tax
provision were partially offset by the reversal of valuation allowances and the tax deduction for
qualified domestic production activities enacted pursuant to the American Jobs Creation Act of
2004. The reversal of the valuation allowances was due in part to improved profitability trends in
Russia and a change to the Russia tax law that enables us to use a greater amount of our Russian
NOLs. Additionally, the implementation of U.S. legal entity restructuring contributed to the
remainder of the valuation allowance reversal.
Earnings Per Share
Dilution
Diluted earnings per share reflects the potential dilution that could occur if equity awards
from our stock compensation plans were exercised and converted into common stock that would then
participate in net income. Our employee equity award issuances have resulted in $0.05, $0.06 and
$0.04 per share of dilution in 2005, 2004 and 2003, respectively.
Diluted Weighted-Average Shares Outstanding
The decrease in shares outstanding reflects the effect of our share repurchase program, which
began in October 1999, partially offset by share issuances from the exercise of stock options. The
amount of shares authorized by the Board of Directors to be repurchased totals 125 million shares,
of which we have repurchased approximately 17 million shares in 2005 and 101 million shares since
the inception of our share repurchase program.
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RESULTS
OF OPERATIONS — 2004
Volume
Our full-year reported worldwide physical case volume increased three percent in 2004 versus
2003. Worldwide volume growth reflects increases in the U.S., Europe and Canada, partially offset
by a flat performance in Mexico.
In the U.S., volume increased by two percent in 2004 versus 2003, driven by a four percent
increase in our cold- drink channel and a one percent increase in our take-home channel. During
2004, we had solid results in our convenience and gas segment and foodservice business segment,
which consists of our on-premise and full-service vending account customers. From a brand
perspective, Trademark Pepsi’s volume was down one percent for the year, due to declines
in brand Pepsi and Pepsi Twist, partially offset by solid growth from our diet
portfolio. Our non-carbonated soft drink portfolio increased 11% for the full year led by the
introduction of Tropicana Juice Drinks and continued growth from
Aquafina.
In Europe, volume grew ten percent in 2004 versus 2003, driven by double-digit increases in
Russia and Turkey. In Russia, we had solid growth in our core brands, coupled with contributions
from new product introductions, including Tropicana Juice and Lipton Iced Tea.
In Turkey, we continue to improve in the areas of execution and distribution, which resulted in
volume increases in brand Pepsi, Aquafina and local brands.
Total volume in Mexico, excluding the impact of acquisitions, was flat for the year. Volume
trends in Mexico improved during the second half of the year, increasing four percent versus the
prior year. Improvement in the second half of the year reflected improved marketplace execution,
brand and package innovation and our focus on consumer value. During the second half of the year,
we saw increases in each of our jug, bottled water and carbonated soft drink categories. Increases
in the second half of the year were offset by volume declines in the first half of the year driven
primarily by our jug water business.
Net Revenues
Worldwide net revenues were $10.9 billion in 2004, a six percent increase over the prior year.
The increase in net revenues for the year was driven by improvements in volume, growth in net
price per case and the favorable impact from currency translation.
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In the U.S., net revenues increased five percent in 2004 versus 2003. The increases in net
revenues in the U.S. were driven by growth in both volume and net price per case. Increases in net
price per case in the U.S. were due to a combination of rate increases, primarily in cans, and mix
benefits from the sale of higher-priced products.
Net revenues outside the U.S. grew approximately eight percent in 2004 versus 2003. The
increases in net revenues outside the U.S. were driven primarily by growth in volume and net price
per case in Europe and Canada, coupled with the favorable impact of foreign exchange. This growth
was partially offset by net revenue declines in Mexico. Net revenues in Mexico declined three
percent on a full-year basis due primarily to the devaluation of the Mexican peso. In local
currency, our net price per case in Mexico in 2004 was flat versus the prior year.
Cost of Sales
Worldwide cost of sales was $5.7 billion in 2004, an eight-percent increase over 2003. The
growth in cost of sales per case was driven primarily by significant increases in raw material
costs, coupled with mix shifts into more expensive products and packages and the negative impact of
foreign currency translation.
In the U.S., cost of sales grew seven percent in 2004 versus 2003, due to volume growth and
increases in cost per case. The increases in cost per case resulted from higher commodity costs,
primarily driven by aluminum and resin, coupled with the impact of mix shifts into more expensive
products and packages.
Cost of sales outside the U.S. grew approximately eleven percent in 2004 versus 2003,
reflecting increases in cost per case and volume, coupled with the negative impact from foreign
currency translation. Growth in cost per case was driven by increases in Europe and Mexico. In
Europe, we experienced higher sweetener costs in Turkey and mix shifts into more expensive products
in Russia. In Mexico, sweetener costs increased throughout the year, coupled with a steep rise in
resin costs in the fourth quarter. Foreign currency translation contributed three percentage
points of growth, reflecting the appreciation of the euro and Canadian dollar, partially offset by
the devaluation of the Mexican peso.
Selling, Delivery and Administrative Expenses
Worldwide selling, delivery and administrative expenses were $4.3 billion, a four-percent
increase over 2003. Increases in selling, delivery and administrative costs were driven by higher
operating costs in the U.S. and Europe, coupled with the negative impact of foreign currency
translation.
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In the U.S., increases reflect higher labor and benefit costs. These increases were partially
offset by reduced operating costs driven from a number of productivity initiatives we put in place
during 2004, coupled with a reduction in our bad debt expense.
Outside the U.S., increases were driven primarily by higher operating costs in Russia and
Turkey and the negative impact of foreign currency throughout Europe and Canada. These increases
were partially offset by declines in Mexico due to the devaluation of the Mexican peso and reduced
operating costs. We consolidated a number of warehouses and distribution systems in Mexico and are
starting to capitalize on productivity gains and reduced costs. These results also included a $9
million non-cash impairment charge related to our re-evaluation of the fair value of our franchise
licensing agreement for the Squirt trademark in Mexico, as a result of a change in its
estimated accounting life. See Note 6 in Notes to Consolidated Financial Statements for additional
information.
Net Interest Expense
Net interest expense decreased by $9 million to $230 million, when compared with 2003, largely
due to lower effective interest rates achieved on our long-term debt.
Minority Interest
Minority interest represents PepsiCo’s approximate 6.8 percent ownership in our principal
operating subsidiary, Bottling Group, LLC.
Income Tax Expense
Our effective tax rate for 2004 and 2003 was 33.7 percent and 36.3 percent, respectively.
The decrease in our effective tax rate versus the prior year is due largely to the lapping of an
$11 million ($0.04 per diluted share) tax charge relating to a Canadian tax law change in the
fourth quarter of 2003. In 2004, we had the following significant tax items, which decreased our
tax expense by approximately $4 million:
LIQUIDITY AND FINANCIAL CONDITION
Cash Flows
Fiscal 2005 Compared with Fiscal 2004
Net cash provided by operations decreased by $3 million to $1,219 million in 2005. Decreases
in net cash provided by operations were driven by higher tax disbursements as a result of the
lapping of the tax stimulus package in 2004 and higher incentive compensation payments in 2005,
partially offset by lower pension contributions and working capital improvements, particularly in
the area of our receivables.
Net cash used for investments increased by $80 million to $842 million, principally reflecting
higher acquisition and capital
spending, partially offset by higher proceeds from sales of property, plant and equipment.
Net cash used for financing decreased by $1,212 million to $183 million driven primarily by
the lapping of the repayment of our $1.0 billion note in February 2004 and lower purchases of
treasury stock, partially offset by higher dividend payouts.
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Fiscal 2004 Compared with Fiscal 2003
Net cash provided by operations grew by $147 million to $1,222 million in 2004. Increases in
net cash provided by operations were driven by higher profits, lower pension contributions and
working capital improvements, which include the lapping of a one-time payment in 2003 relating to
the settlement of our New Jersey wage and hour litigation. These increases were partially offset
by higher tax payments.
Net cash used for investments increased by $37 million to $762 million, principally reflecting
higher capital spending, partially offset by higher proceeds from sales of property, plant and
equipment.
Net cash used for financing increased by $2,048 million to $1,395 million driven primarily by
the repayment of our $1.0 billion note in February 2004, lower proceeds from long-term borrowings
and higher share repurchases, partially offset by increased stock option exercises and higher
short-term borrowings.
Liquidity and Capital Resources
We believe that our future cash flows from operations and borrowing capacity will be
sufficient to fund capital expenditures, acquisitions, dividends and working capital requirements
for the foreseeable future.
We have a $500 million commercial paper program in the U.S. that is supported by a credit
facility, which is guaranteed by Bottling Group, LLC and expires in April 2009. At December 31,
2005, we had $355 million in outstanding commercial paper with a weighted-average interest rate of
4.30 percent. At December 25, 2004, we had $78 million in outstanding commercial paper with a
weighted-average interest rate of 2.32 percent.
We had available bank credit lines of approximately $835 million at December 31, 2005. These
lines were used to support the general operating needs of our businesses. As of year-end 2005, we
had $156 million outstanding under these lines of credit at a weighted-average interest rate of
4.33 percent. As of year-end 2004, we had available short-term bank credit lines of approximately
$381 million and $77 million was outstanding under these lines of credit at a weighted-average
interest rate of 3.72 percent.
Certain of our other senior notes have redemption features and non-financial covenants
that will, among other things, limit our ability to create or assume liens, enter into sale and
lease-back transactions, engage in mergers or consolidations and transfer or lease all or
substantially all of our assets. Additionally, certain of our credit facilities and senior notes
have financial covenants consisting of the following:
We are in compliance with all debt covenants.
Our peak borrowing timeframe varies with our working capital requirements and the seasonality
of our business. Additionally, throughout the year, we may have further short-term borrowing
requirements driven by other operational needs of our business. During 2005, borrowings from our
commercial paper program in the U.S. peaked at $355 million. Outside the U.S., borrowings from our
international credit facilities peaked at $234 million, reflecting payments for working capital
requirements.
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Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2005:
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements that have or are reasonably likely to have a
current or future material effect on our financial condition, results of operations, liquidity,
capital expenditures or capital resources.
Capital Expenditures
Our business requires substantial infrastructure investments to maintain our existing level of
operations and to fund investments targeted at growing our business. Capital infrastructure
expenditures totaled $715 million, $688 million and $635 million during 2005, 2004 and 2003,
respectively.
Acquisitions
In September 2005, we acquired the operations and exclusive right to manufacture, sell and
distribute Pepsi-Cola beverages from the Pepsi-Cola Bottling Company of Charlotte, North Carolina.
The acquisition did not have a material impact on our Consolidated Financial Statements.
As a result of the acquisition, we have assigned $70 million to goodwill, $118 million to
franchise rights and $12 million to non-compete arrangements. The goodwill and franchise rights
are not subject to amortization. The non-compete agreements are being amortized over ten years. The
allocations of the purchase price for the acquisition are still preliminary and will be determined
based on the estimated fair value of assets acquired and liabilities assumed as of the date of the
acquisition. The operating results of the acquisition are included in the accompanying Consolidated
Financial Statements from its date of purchase. The acquisition was made to enable us
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to provide better service to our large retail customers. We expect the acquisition to
reduce costs through economies of scale.
During 2004, we acquired the operations and exclusive right to manufacture, sell and
distribute Pepsi-Cola beverages from four franchise bottlers. The following acquisitions occurred
for an aggregate purchase price of $95 million in cash and assumption of liabilities of $22
million:
As a result of these acquisitions, we have assigned $5 million to goodwill, $66 million to
franchise rights and $3 million to non-compete arrangements. The goodwill and franchise rights are
not subject to amortization. The non-compete agreements are being amortized over five to ten years.
During 2004, we also paid $1 million for the purchase of certain distribution rights relating
to SoBe.
We intend to continue to pursue other acquisitions of independent PepsiCo bottlers,
particularly in territories contiguous to our own, where they create shareholder value.
MARKET RISKS AND CAUTIONARY STATEMENTS
Quantitative and Qualitative Disclosures about Market Risk
In the normal course of business, our financial position is routinely subject to a variety of
risks. These risks include the risk associated with the price of commodities purchased and used in
our business, interest rates on outstanding debt and currency movements of non-U.S. dollar
denominated assets and liabilities. We are also subject to the risks associated with the business
environment in which we operate, including the collectibility of accounts receivable. We regularly
assess all of these risks and have policies and procedures in place to protect against the adverse
effects of these exposures.
Our objective in managing our exposure to fluctuations in commodity prices, interest rates and
foreign currency exchange rates is to minimize the volatility of earnings and cash flows associated
with changes in the applicable rates and prices. To achieve this objective, we have derivative
instruments to hedge against the risk of adverse movements in commodity prices, interest rates and
foreign currency. Our corporate policy prohibits the use of derivative instruments for trading or
speculative purposes, and we have procedures in place to monitor and control their use. See Note
11 in Notes to Consolidated Financial Statements for additional information relating to our
derivative instruments.
A sensitivity analysis has been prepared to determine the effects that market risk exposures
may have on our financial instruments. We performed the
sensitivity analyses for hypothetical changes in commodity prices, interest rates and foreign
currency exchange rates and changes in our stock price on our unfunded deferred compensation
liability. Information provided by these sensitivity analyses does not necessarily represent the
actual changes in fair value that we would incur under normal market conditions because, due to
practical limitations, all variables other than the specific market risk factor were held constant.
As a result, the reported changes in the values of some financial instruments that are affected by
the sensitivity analyses are not matched with the offsetting changes in the values of the items
that those instruments are designed to finance or hedge.
Commodity Price Risk
We are subject to market risks with respect to commodities because our ability to recover
increased costs through higher pricing may be limited by the competitive environment in which we
operate. We use futures contracts and options on futures in the normal course of business to hedge
anticipated purchases of certain commodities used in our operations. With respect to commodity
price risk, we currently have various contracts outstanding for commodity purchases in 2006 and
2007, which establish our purchase prices within defined ranges. We
estimate that a 10-percent
decrease in commodity prices with all other variables held constant would
have resulted in a decrease in the fair value of our financial instruments of $1 million and
$10 million at December 31, 2005 and December 25, 2004, respectively.
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Interest Rate Risk
Interest
rate risk is present with both fixed and floating-rate debt. We use interest rate swaps to manage our interest expense risk. These instruments effectively change the interest rate of specific debt issuances. As a result, changes in interest
rates on our variable debt would change our interest expense. We estimate that a 50-basis point
increase in interest rates on our variable rate debt and cash equivalents with all other variables
held constant would have resulted in an increase to net interest expense of $4 million in both 2005
and 2004.
Foreign Currency Exchange Rate Risk
In 2005, approximately 29 percent of our net revenues came from outside the United States.
Social, economic and political conditions in these international markets may adversely affect our
results of operations, cash flows and financial condition. The overall risks to our international
businesses include changes in foreign governmental policies and other political or economic
developments. These developments may lead to new product pricing, tax or other policies and
monetary fluctuations that may adversely impact our business. In addition, our results of
operations and the value of the foreign assets and liabilities are affected by fluctuations in
foreign currency exchange rates.
As currency exchange rates change, translation of the statements of operations of our
businesses outside the U.S. into U.S. dollars affects year-over-year comparability. We generally
have not hedged against these types of currency risks because cash flows from our international
operations are usually reinvested locally.
We have foreign currency transactional risks in certain of our international territories for
transactions that are denominated in currencies that are different from their functional currency.
We have entered into forward exchange contracts to hedge portions of our forecasted U.S. dollar
cash flows in our Canadian business. A 10-percent weaker U.S. dollar against the Canadian dollar,
with all other variables held constant, would result in a decrease in the fair value of these contracts
of $9 million and $10 million at December 31, 2005 and
December 25, 2004, respectively.
Foreign currency gains and losses reflect both transaction gains and losses in our foreign
operations, as well as translation gains and losses arising from the re-measurement into U.S.
dollars of the net monetary assets of businesses in highly inflationary countries. Turkey is
considered a highly inflationary economy for accounting purposes.
Beginning in 2006, Turkey will no longer be considered highly inflationary, and will change
its functional currency from the U.S. Dollar to the Turkish Lira. We do not expect any material
impact on our consolidated financial statements as a result of Turkey’s change in functional
currency.
Unfunded Deferred Compensation Liability
Our unfunded deferred compensation liability is subject to changes in our stock price as well
as price changes in certain other equity and fixed income investments. Employees participating in
our deferred compensation program can elect to defer all or a portion of their compensation to be
paid out on a future date or dates. As part of the deferral process, employees select from phantom
investment options that determine the earnings on the deferred compensation liability and the
amount that they will ultimately receive. Employee investment elections include PBG stock and a
variety of other equity and fixed-income investment options.
Since the plan is unfunded, employees’ deferred compensation amounts are not directly invested
in these investment vehicles. Instead, we track the performance of each employee’s investment
selections and adjust his or her deferred compensation account accordingly. The adjustments to the
employees’ accounts increase or decrease the deferred compensation liability reflected on our
Consolidated Balance Sheets with an offsetting increase or decrease to our selling, delivery and
administrative expenses.
We use prepaid forward contracts to hedge the portion of our deferred compensation liability
that is based on our stock price. Therefore, changes in compensation expense as a result of changes
in our stock price are substantially offset by the changes in the fair value of these contracts. We
estimate that a 10-percent unfavorable change in the year-end stock price would have reduced the
fair value from these commitments by $2 million in 2005 and 2004.
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Cautionary Statements
Except for the historical information and discussions contained herein, statements contained
in this annual report on Form 10-K and in the annual report to the shareholders may constitute
forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are based on currently available competitive, financial and
economic data and our operating plans. These statements involve a number of risks, uncertainties
and other factors that could cause actual results to be materially different. Among the events and
uncertainties that could adversely affect future periods are:
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The Pepsi Bottling Group, Inc.
Consolidated Statements of Operations Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003
in millions, except per share data
See accompanying notes to Consolidated Financial Statements.
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The Pepsi Bottling Group, Inc.
Consolidated Statements of Cash Flows Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003
in millions
See accompanying notes to Consolidated Financial Statements.
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The Pepsi Bottling Group, Inc.
Consolidated Balance Sheets December 31, 2005 and December 25, 2004
in millions, except per share data
See accompanying notes to Consolidated Financial Statements.
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The Pepsi Bottling Group, Inc.
Consolidated Statements of Changes in Shareholders’ Equity Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003
See accompanying notes to Consolidated Financial Statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Tabular dollars in millions, except per share data
Note 1—Basis of Presentation
The Pepsi Bottling Group, Inc. (“PBG” or the “Company”) is the world’s largest manufacturer,
seller and distributor of Pepsi-Cola beverages. We have the exclusive right to manufacture, sell
and distribute Pepsi-Cola beverages in all or a portion of the United States, Mexico, Canada and
Europe, which consists of operations in Spain, Greece, Russia and Turkey. When used in these
Consolidated Financial Statements, “PBG,” “we,” “our” and “us” each refers to The Pepsi Bottling
Group, Inc. and, where appropriate, to Bottling Group, LLC (“Bottling LLC”), our principal
operating subsidiary.
At December 31, 2005, PepsiCo, Inc. (“PepsiCo”) owned 98,511,358 shares of our common stock,
consisting of 98,411,358 shares of common stock and 100,000 shares of Class B common stock. All
shares of Class B common stock that have been authorized have been issued to PepsiCo. At December
31, 2005, PepsiCo owned approximately 41.2 percent of our outstanding common stock and 100 percent
of our outstanding Class B common stock, together representing 46.8 percent of the voting power of
all classes of our voting stock. In addition, PepsiCo owns approximately 6.7 percent of the equity
of Bottling LLC. We fully consolidate the results of Bottling LLC and present PepsiCo’s share as
minority interest in our Consolidated Financial Statements.
The common stock and Class B common stock both have a par value of $0.01 per share and are
substantially identical, except for voting rights. Holders of our common stock are entitled to one
vote per share and holders of our Class B common stock are entitled to 250 votes per share. Each
share of Class B common stock is convertible into one share of common stock. Holders of our common
stock and holders of our Class B common stock share equally on a per-share basis in any dividend
distributions.
Our Board of Directors has the authority to issue up to 20,000,000 shares of preferred stock,
and to determine the price and terms, including, but not limited to, preferences and voting rights
of those shares without stockholder approval. At December 31, 2005, there was no preferred stock
outstanding.
Certain reclassifications were made in our Consolidated Financial Statements to 2004 and 2003
amounts to conform to the 2005 presentation.
Note 2—Summary of Significant Accounting Policies
Basis of Consolidation — The accounts of all of our wholly and majority-owned subsidiaries are
included in the accompanying Consolidated Financial Statements. We have eliminated intercompany
accounts and transactions in consolidation.
Fiscal Year — Our U.S. and Canadian operations report using a fiscal year that consists of
fifty-two weeks, ending on the last Saturday in December. Every five or six years a fifty-third
week is added. In 2005, our fiscal year consisted of fifty-three weeks (the additional week was
added to the fourth quarter). Fiscal years 2004 and 2003 consisted of fifty-two weeks. Our
remaining countries report using a calendar-year basis. Accordingly, we recognize our quarterly
business results as outlined below:
Revenue Recognition — Revenue, net of sales returns, is recognized when our products are
delivered or shipped to customers in accordance with the written sales terms. We offer certain
sales incentives on a local and national level through various customer trade agreements designed
to enhance the growth of our revenue. Customer trade agreements are accounted for as a reduction to
our revenues.
Customer trade agreements with our customers include payments for in-store displays, volume
rebates, featured advertising and other growth incentives. A number of our customer trade
agreements are based on quarterly and annual targets that generally do not exceed one year.
Estimated amounts to be paid to our customers for trade
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agreements are based upon current performance, historical experience, forecasted volume and
other performance criteria.
Advertising and Marketing Costs — We are involved in a variety of programs to promote our
products. We include advertising and marketing costs in selling, delivery and administrative
expenses. Advertising and marketing costs were $421 million, $426 million
and $453 million in 2005, 2004 and 2003, respectively, before bottler incentives received from
PepsiCo and other brand owners.
Bottler Incentives — PepsiCo and other brand owners, at their discretion, provide us with
various forms of bottler incentives. These incentives cover a variety of initiatives, including
direct marketplace support and advertising support. We classify bottler incentives as follows:
Total bottler incentives recognized as adjustments to net revenues, cost of sales and selling,
delivery and administrative expenses in our Consolidated Statements of Operations were as follows:
Shipping and Handling Costs — Our shipping and handling costs are recorded primarily within
selling, delivery and administrative expenses. Such costs recorded within selling, delivery and
administrative expenses totaled $1.5 billion, $1.6 billion and $1.4 billion in 2005, 2004 and 2003,
respectively.
Foreign Currency Gains and Losses — We translate the balance sheets of our foreign
subsidiaries that do not operate in highly inflationary economies at the exchange rates in effect
at the balance sheet date, while we translate the statements of operations at the average rates of
exchange during the year. The resulting translation adjustments of our foreign subsidiaries are
recorded directly to accumulated other comprehensive loss. Foreign currency gains and losses
reflect both transaction gains and losses in our foreign operations, as well as translation gains
and losses arising from the re-measurement into U.S. dollars of the net monetary assets of
businesses in highly inflationary countries. Beginning January 1, 2006, Turkey is no longer
considered to be a highly inflationary economy for accounting purposes. We do not expect any
material impact on our consolidated financial statements as a result of Turkey’s change in
functional currency.
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Pension and Postretirement Medical Benefit Plans — We sponsor pension and other postretirement
medical benefit plans in various forms covering substantially all employees who meet eligibility
requirements. We account for our defined benefit pension plans and our postretirement medical
benefit plans using actuarial models required by Statement of Financial Accounting Standards
(“SFAS”) No. 87, “Employers’ Accounting for Pensions,” and SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions.”
The assets, liabilities and assumptions used to measure pension and postretirement medical
expense for any fiscal year are determined as of September 30 of the preceding year (“measurement
date”). The discount rate assumption used in our pension and postretirement medical benefit plans’
accounting is based on current interest rates for high-quality, long–term corporate debt as
determined on each measurement date. In evaluating the expected rate of return on assets for a
given fiscal year, we consider both projected future returns of asset classes and the actual 10 to
15-year historic returns on asset classes in our pension investment portfolio, reflecting the
weighted-average return of our asset allocation. Differences between actual and expected returns
are recognized in the net periodic pension calculation over five years. To the extent the amount of
all unrecognized gains and losses exceeds 10 percent of the larger of the pension benefit
obligation or plan assets, such amount is amortized over the average remaining service period of
active participants. We amortize prior service costs on a straight-line basis over the average
remaining service period of employees expected to receive benefits.
Income Taxes — Our effective tax rate is based on pre-tax income, statutory tax rates, tax
regulations and tax planning strategies available to us in the various jurisdictions in which we
operate. The tax bases of our assets and liabilities reflect our best estimate of the tax benefit
and costs we expect to realize. We establish valuation allowances to reduce our deferred tax
assets to an amount that will more likely than not be realized.
Significant management judgment is required in determining our effective tax rate and in
evaluating our tax position. We establish reserves when, based on the applicable tax law and facts
and circumstances relating to a particular transaction or tax
position, it becomes probable
that the position will not be sustained when challenged by a taxing authority. A change in our tax
reserves could have a significant impact on our results of operations.
Earnings Per Share — We compute basic earnings per share by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted earnings per share
reflect the potential dilution that could occur if securities or other contracts to issue common
stock were exercised and converted into common stock that would then participate in net income.
Cash Equivalents — Cash equivalents represent funds we have temporarily invested with original
maturities not exceeding three months.
Allowance for Doubtful Accounts — A portion of our accounts receivable will not be collected
due to bankruptcies and sales returns. Our accounting policy for the provision for doubtful
accounts requires reserving an amount based on the evaluation of the aging of accounts receivable,
sales return trend analysis, detailed analysis of high-risk customers accounts, and the overall
market and economic conditions of our customers.
Inventories — We value our inventories at the lower of cost or net realizable value. The cost
of our inventory is generally computed on the first-in, first-out method.
Property, Plant and Equipment — We state property, plant and equipment (“PP&E”) at cost,
except for PP&E that has been impaired, for which we write down the carrying amount to estimated
fair market value, which then becomes the new cost basis.
Goodwill and Other Intangible Assets, net — Goodwill and intangible assets with indefinite
useful lives are not amortized, but instead tested annually for impairment.
We evaluate our identified intangible assets with indefinite useful lives for impairment
annually (unless it is required more frequently because of a triggering event). We measure impairment as the amount by which the carrying value exceeds its estimated fair
value. Based upon our annual impairment analysis performed in the fourth quarter of 2005, the
estimated fair values of our identified intangible assets with indefinite lives exceeded their
carrying amounts.
We evaluate goodwill on a country-by-country basis (“reporting unit”) for impairment. We
evaluate each reporting unit for impairment based upon a two-step approach. First, we compare the
fair value of our reporting unit with its carrying value. Second, if the carrying value of our
reporting unit exceeds its fair value, we compare the implied fair value of the reporting unit’s
goodwill to its carrying amount to measure the amount of impairment loss. In measuring the implied
fair value of goodwill, we would allocate the fair value of the reporting unit to each of its
assets and liabilities (including any unrecognized intangible assets). Any excess of the fair
value of the reporting
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unit over the amounts assigned to its assets and liabilities is the implied fair value of
goodwill. Based upon our annual impairment analysis in the fourth quarter of 2005, the estimated
fair value of our reporting units exceeded their carrying value, and as a result, we did not need
to proceed to the second step of the impairment test.
Other identified intangible assets that are subject to amortization are amortized on a
straight-line basis over the period in which we expect to receive economic benefit and are reviewed
for impairment when facts and circumstances indicate that the carrying value of the asset may not
be recoverable. The determination of the expected life will be dependent upon the use and
underlying characteristics of the intangible asset. In our evaluation of the intangible assets, we
consider the nature and terms of the underlying agreements, the customer’s attrition rate,
competitive environment and brand history, as applicable. If the carrying value is not recoverable,
impairment is measured as the amount by which the carrying value exceeds its estimated fair value.
Fair value is generally estimated based on either appraised value or other valuation techniques.
Casualty
Insurance Costs — In the United States, we are self-insured or have large deductible
programs for workers’ compensation and automobile risks for occurrences up to $10 million, and
product and general liability risks for occurrences up to $5 million. For losses exceeding these
self-insurance thresholds, we purchase casualty insurance from a third-party provider. Our
liability for casualty costs was $188 million as of December 31, 2005 of which $61 million was
reported in accounts payable and other current liabilities and $127 million was recorded in other
liabilities in our Consolidated Balance Sheets. Our liability for casualty costs is estimated using
individual case-based valuations and statistical analyses and is based upon historical experience,
actuarial assumptions and professional judgment. We do not discount our loss expense reserves.
Minority Interest — PBG and PepsiCo contributed bottling businesses and assets used in the
bottling businesses to Bottling Group, LLC, our principal operating subsidiary, in connection with
the formation of Bottling Group, LLC in February 1999. At December 31, 2005, PBG owns 93.3 percent
of Bottling Group, LLC and PepsiCo owns the remaining 6.7 percent. Accordingly, the Consolidated
Financial Statements reflect PepsiCo’s share of the consolidated net income of Bottling Group, LLC
as minority interest in our Consolidated Statements of Operations, and PepsiCo’s share of
consolidated net assets of Bottling Group, LLC as minority interest in our Consolidated Balance
Sheets.
Treasury Stock — We record the repurchase of shares of our common stock at cost and classify
these shares as treasury stock within shareholders’ equity. Repurchased shares are included in our
authorized and issued shares but not included in our shares outstanding. We record shares
reissued using an average cost. At December 31, 2005 we had 125 million shares authorized under
our share repurchase program. Since the inception of our share repurchase program in October 1999,
we have repurchased approximately 101 million shares and have reissued approximately 30 million for
stock option exercises.
Financial Instruments and Risk Management — We use derivative instruments to hedge against the
risk of adverse movements associated with commodity prices, interest rates and foreign currency.
Our corporate policy prohibits the use of derivative instruments for trading or speculative
purposes, and we have procedures in place to monitor and control their use.
All derivative instruments are recorded at fair value as either assets or liabilities in our
Consolidated Balance Sheets. Derivative instruments are generally designated and accounted for as
either a hedge of a recognized asset or liability (“fair value hedge”) or a hedge of a forecasted
transaction (“cash flow hedge”). The derivative’s gain or loss recognized in earnings is recorded
consistent with the expense classification of the underlying hedged item.
If a fair value or cash flow hedge were to cease to qualify for hedge accounting or were
terminated, it would continue to be carried on the balance sheet at fair value until settled, but
hedge accounting would be discontinued prospectively. Amounts previously deferred in accumulated
other comprehensive loss would be recognized immediately in earnings.
We also may enter into a derivative instrument for which hedge accounting is not required
because it is entered into to offset changes in the fair value of an underlying transaction
recognized in earnings (“natural hedge”). These instruments are reflected in the Consolidated
Balance Sheets at fair value with changes in fair value recognized in earnings.
Stock-Based Employee Compensation - We measure stock-based compensation expense using the
intrinsic-value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees,” and its related interpretations. Accordingly,
compensation expense for stock option grants to
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our employees is measured as the excess of the quoted market price of common stock at the
grant date over the amount the employee must pay for the stock. Our policy is to grant stock
options at fair value on the date of grant. As allowed by SFAS No. 148, “Accounting for Stock-Based
Compensation — Transition and Disclosure,” we have elected to continue to apply the intrinsic-value
based method of accounting described above, and have adopted the disclosure requirements of SFAS
No. 123, “Accounting for Stock-Based Compensation.” If we had measured compensation cost for the
stock awards granted to our employees under the fair-value based method prescribed by SFAS No. 123,
net income would have been changed to the pro forma amounts set forth below:
Pro forma compensation cost measured for equity awards granted to employees is amortized using
a straight-line basis over the vesting period, which is typically three years.
The fair value of PBG stock options used to compute pro forma net income disclosures was
estimated on the date of grant using the Black-Scholes-Merton option-pricing model based on the
weighted-average assumption for options granted in the following years:
SFAS No. 123R
In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revised Statement
of Financial Accounting Standards (“SFAS”) No. 123, “Share-Based Payment” (“SFAS 123R”). Among its
provisions, SFAS 123R will require us to measure the value of employee services in exchange for an
award of equity instruments based on the grant-date fair value of the award and to recognize the
cost over the requisite service period. SFAS 123R eliminates the alternative use of Accounting
Principles Board (“APB”) No. 25’s intrinsic-value method of accounting for awards. In fiscal year
2005 and earlier, the Company accounted for stock options according to the provisions of APB No. 25
and related interpretations, and accordingly no compensation expense was required.
The Company will adopt SFAS 123R in the first quarter of 2006 by using the modified
prospective approach. Under this method, we will recognize compensation expense for all share-based
payments over the vesting period based on their grant-date fair value. Measurement and our method
of amortization of costs for share-based payments granted prior to, but not vested as of the date
of adoption, would be based on the same estimate of the grant-date fair value and the same
amortization method that was previously used in our SFAS 123 pro forma disclosure. Prior periods
will not be restated. Currently, the Company uses the Black-Scholes-Merton option-
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pricing model to estimate the value of stock options granted to employees in its pro forma
disclosure and plans to continue to use this method upon adoption of SFAS 123R.
The financial statement impact will be dependent on future stock-based awards and any unvested
stock options outstanding at the date of adoption. We expect the adoption of SFAS 123R to reduce
our 2006 diluted EPS by $0.18 per share.
Commitments and Contingencies — We are subject to various claims and contingencies related to
lawsuits, taxes, environmental and other matters arising out of the normal course of business.
Liabilities related to commitments and contingencies are recognized when a loss is probable and
reasonably estimable.
New Accounting Standards
SFAS No. 123R
See discussion in “Stock-Based Employee Compensation” above.
FASB Staff Position No. FAS 109-1
In December 2004, the FASB issued Staff Position No. FAS 109-1 (“FSP 109-1”), “Application of
FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004.” FSP 109-1 clarifies SFAS No. 109’s
guidance that applies to the new tax deduction for qualified domestic production activities. The
tax deduction for qualified production activities is effective for our 2005 tax year. This tax
deduction reduced our income tax provision by $7 million in 2005.
FASB Staff Position No. FAS 109-2
In December 2004, the FASB issued Staff Position No. FAS 109-2 (“FSP 109-2”), “Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs
Creation Act of 2004.” FSP 109-2 provides that an enterprise is allowed time beyond the financial
reporting period of enactment to evaluate the effect of the new tax law on its plan for applying
SFAS No. 109 to the repatriation provisions of the Act. PBG evaluated the Foreign Earnings
Repatriation Provision and based on the facts surrounding our foreign operations, decided not to
repatriate any of our foreign earnings and profits pursuant to the provision.
FASB Interpretation No. 47
In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional
Asset Retirement Obligations,” that requires an entity to recognize a liability for a conditional
asset retirement obligation when incurred if the liability can be reasonably estimated. FIN 47
clarifies that the term Conditional Asset Retirement Obligation refers to a legal obligation to
perform an asset retirement activity in which the timing and/or method of settlement are
conditional on a future event that may or may not be within the control of the entity. FIN 47 also
clarifies when an entity would have sufficient information to estimate reasonably the fair value of
an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. This standard did not have a material impact on our Consolidated Financial
Statements.
SFAS No. 151
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43,
Chapter 4” (“SFAS 151”). SFAS 151 clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage). In addition, this statement
requires that allocation of fixed production overheads to the costs of conversion be based on
normal capacity of production facilities. SFAS 151 is effective for the first annual reporting
period beginning after June 15, 2005. The adoption of SFAS 151 did not have a material impact on
our Consolidated Financial Statements.
Emerging
Issues Task Force (“EITF”) Issue No. 02-16 “Accounting
by a Customer (including a Reseller) for Certain Consideration
Received from a Vendor”
The EITF reached a consensus on Issue No. 02-16 in 2003, addressing the recognition and income
statement classification of various cash consideration received from a vendor. In accordance with
EITF Issue No.
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02-16, we have reclassified certain bottler incentives from revenue and selling, delivery and
administrative expenses to cost of sales beginning in 2003. During 2003, we recorded a transition
adjustment of $6 million, net of taxes and minority interest of $1 million, for the cumulative
effect on prior years. This adjustment reflects the amount of bottler incentives that can be
attributed to our 2003 beginning inventory balances.
Assuming EITF Issue No. 02-16 had been adopted for all periods presented, pro forma net income
and earnings per share for the years ended December 31, 2005, December 25, 2004, and December 27,
2003, would have been as follows:
Note 3—Inventories
Note 4—Prepaid Expenses and Other Current Assets
Note 5—Accounts Receivable
Note 6—Property, Plant and Equipment, net
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We calculate depreciation on a straight-line basis over the estimated lives of the assets as
follows:
Note 7–Other Intangible Assets, net and Goodwill
In 2005, total other intangible assets, net and goodwill increased by approximately $275
million due to the following:
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In 2004, total other intangible assets, net and goodwill increased by approximately $107
million due to the following:
During the fourth quarter of 2004 we recorded a $9 million non-cash impairment charge ($6
million net of tax and minority interest) in selling, delivery and administrative expenses relating
to our re-evaluation of the fair value of our franchise licensing agreement for the
Squirt trademark in Mexico, as a result of a change in its estimated accounting life. The
franchise licensing agreements for the Squirt trademark were considered to have an
indefinite life and granted The Pepsi Bottling Group Mexico S.R.L. (“PBG Mexico”) the exclusive
right to produce, sell and distribute beverages under the Squirt trademark in certain
territories of Mexico. In December 2004, Cadbury Bebidas, S.A. de C.V. (“Cadbury Mexico”), the
owner of the Squirt trademark, sent PBG Mexico notices that purportedly terminated the
Squirt licenses for these territories effective January 15, 2005. PBG Mexico believes
that these licenses continue to be in effect and that Cadbury Mexico has no legally supportable
basis to terminate the licenses. However, as a result of these unanticipated actions, PBG Mexico
was no longer certain that it will have the right to distribute Squirt in Mexico after
certain of its contractual rights expire in 2015. Accordingly, we have concluded that the
franchise rights relating to the Squirt trademark should no longer be considered to have
an indefinite life, but should be treated as having a 10-year life for accounting purposes. Due to
the reduction in the useful life of these franchise rights, we wrote the carrying value of the
Squirt franchise rights down to its current estimated fair value in 2004. The remaining
carrying value will be amortized over the estimated useful life of 10 years.
We measured the fair value of Squirt’s franchise rights using a multi-period excess
earnings method, which was based upon estimated discounted future cash flows for 10 years. We
deducted a contributory charge from our net after-tax cash flows for the economic return
attributable to the working capital and property, plant and equipment, for Squirt’s
franchise rights. The net discounted cash flows in excess of the fair returns on these assets
represent the fair value of the Squirt franchise rights.
For intangible assets subject to amortization, we calculate amortization expense over the
period we expect to receive economic benefit. Total amortization expense was $15 million, $13
million and $12 million in 2005, 2004 and 2003, respectively. The weighted-average amortization
period for each category of intangible assets and its estimated aggregate amortization expense
expected to be recognized over the next five years are as follows:
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Note 8—Accounts Payable and Other Current Liabilities
Note 9—Short-term Borrowings and Long-term Debt
Maturities
of long-term debt as of December 31, 2005 are as follows: 2006: $594 million, 2007: $13
million, 2008: $1 million, 2009: $1,300 million, 2010: $0 million and thereafter, $2,653 million.
The maturities of long-term debt do not include the non-cash impact of the SFAS No. 133 adjustment
and the interest effect of the unamortized discount.
Our $1.3 billion of 5.63 percent senior notes due in 2009 and our $1.0 billion of 4.63 percent
senior notes due in 2012 are guaranteed by PepsiCo.
We have a $500 million commercial paper program in the U.S. that is supported by a credit
facility, which is guaranteed by Bottling Group, LLC and expires in April 2009. At December 31,
2005, we had $355 million in outstanding commercial paper with a weighted-average interest rate of
4.30 percent. At December 25, 2004, we had $78 million in outstanding commercial paper with a
weighted-average interest rate of 2.32 percent.
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We had available bank credit lines of approximately $835 million at December 31, 2005. These
lines were used to support the general operating needs of our businesses. As of year-end 2005, we
had $156 million outstanding under these lines of credit at a weighted-average interest rate of
4.33 percent. As of year-end 2004, we had available short-term bank credit lines of approximately $381 million and $77 million was outstanding
under these lines of credit at a weighted-average interest rate of 3.72 percent.
Certain of our senior notes have redemption features and non-financial covenants that will,
among other things, limit our ability to create or assume liens, enter into sale and lease-back
transactions, engage in mergers or consolidations and transfer or lease all or substantially all of
our assets. Additionally, certain of our credit facilities and senior notes have financial
covenants consisting of the following:
We are in compliance with all debt covenants.
Our peak borrowing timeframe varies with our working capital requirements and the seasonality
of our business. Additionally, throughout the year, we may have further short-term borrowing
requirements driven by other operational needs of our business. During 2005, borrowings from our
commercial paper program in the U.S. peaked at $355 million. Outside the U.S., borrowings from our
international credit facilities peaked at $234 million, reflecting payments for working capital
requirements.
Amounts paid to third parties for interest, net of cash received from our interest rate swaps,
was $246 million, $232 million and $243 million in 2005, 2004 and 2003, respectively. Total
interest expense incurred during 2005, 2004 and 2003 was $258 million, $236 million and $247
million, respectively.
At December 31, 2005, we have outstanding letters of credit, bank guarantees and surety bonds
valued at $276 million from financial institutions primarily to provide collateral for estimated
self-insurance claims and other insurance requirements.
Note 10—Leases
We have non-cancelable commitments under both capital and long-term operating leases, which
consist principally of buildings, office equipment and machinery. Certain of our operating leases
for our buildings contain escalation clauses, holiday rent allowances and other rent incentives.
We recognize rent expense on our operating leases, including these allowances and incentives, on a
straight-line basis over the lease term. Capital and operating lease commitments expire at various
dates through 2072. Most leases require payment of related executory costs, which include property
taxes, maintenance and insurance.
At December 31, 2005, the present value of minimum payments under capital leases was $5
million, after deducting $1 million for imputed interest. We plan to receive $5 million of sublease
income for the periods 2006 through 2013.
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Our future minimum commitments under non-cancelable leases as of December 31, 2005 and rental expense
under operating leases are set forth below:
Components
of rental expense under operating leases:
Note 11—Financial Instruments and Risk Management
Cash Flow Hedges — We are subject to market risk with respect to the cost of commodities
because our ability to recover increased costs through higher pricing may be limited by the
competitive environment in which we operate. We use future and option contracts to hedge the risk
of adverse movements in commodity prices related primarily to anticipated purchases of aluminum and
fuel used in our operations. These contracts generally range from one to 12 months in duration and
qualify for cash flow hedge accounting treatment.
We are subject to foreign currency transactional risks in certain of our international
territories for transactions that are denominated in currencies that are different from their
functional currency. Beginning in 2004, we entered into forward exchange contracts to hedge
portions of our forecasted U.S. dollar purchases in our Canadian business. These
contracts generally range from one to 12 months in duration and qualify for cash flow hedge
accounting treatment.
We have also entered into several treasury rate lock agreements to hedge against adverse
interest rate changes on certain debt financing arrangements.
For a cash flow hedge, the effective portion of the change in the fair value of a derivative
instrument, which is highly effective, is deferred in accumulated other comprehensive loss until
the underlying hedged item is recognized in earnings. The ineffective portion of a fair value
change on a qualifying cash flow hedge is recognized in earnings immediately and is recorded
consistent with the expense classification of the underlying hedged item.
The following summarizes activity in accumulated other comprehensive loss (“AOCL”) related to
derivatives designated as cash flow hedges held by the Company during the applicable periods:
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Assuming no change in the commodity prices and foreign currency rates as measured on December
31, 2005, $2 million of deferred loss will be recognized in earnings over the next 12 months.
The ineffective portion of the change in fair value of these contracts was not material to our
results of operations in 2005, 2004 or 2003.
Fair
Value Hedges — We finance a portion of our operations through fixed-rate debt
instruments. We effectively converted $800 million of our senior notes to floating rate debt
through the use of interest rate swaps with the objective of reducing our overall borrowing costs.
These interest rate swaps meet the criteria for fair value hedge accounting and are 100 percent
effective in eliminating the market rate risk inherent in our long-term debt. Accordingly, any
gain or loss associated with these swaps is fully offset by the opposite market impact on the
related debt. The change in fair value of the interest rate swaps was a decrease of $15 million and
$7 million in 2005 and 2004, respectively. In 2005, the current portion of the fair value change
of our swaps and debt has been recorded in accounts payable and other current liabilities and
current maturities of long-term debt in our Consolidated Balance Sheets. The long-term portion of
the change in 2005 has been recorded in other liabilities and long-term debt. In 2004, the fair
value change of our swaps and debt has been recorded in other liabilities and long-term debt in our
Consolidated Balance Sheets.
Unfunded
Deferred Compensation Liability — Our unfunded deferred compensation liability is
subject to changes in our stock price as well as price changes in other equity and fixed-income
investments. Participating employees in our deferred compensation program can elect to defer all
or a portion of their compensation to be paid out on a future date or dates. As part of the
deferral process, employees select from phantom investment options that determine the earnings on
the deferred compensation liability and the amount that they will ultimately receive. Employee
investment elections include PBG stock and a variety of other equity and fixed-income investment
options.
Since the plan is unfunded, employees’ deferred compensation amounts are not directly invested
in these investment vehicles. Instead, we track the performance of each employee’s investment
selections and adjust his or her deferred compensation account accordingly. The adjustments to the
employees’ accounts increases or decreases the deferred compensation liability reflected on our
Consolidated Balance Sheets with an offsetting increase or decrease to our selling, delivery and
administrative expenses.
We use prepaid forward contracts to hedge the portion of our deferred compensation liability
that is based on our stock price. At December 31, 2005, we had a prepaid forward contract for
710,000 shares at a price of $29.34, which was accounted for as a natural hedge. This contract
requires cash settlement and has a fair value at December 31, 2005, of $20 million recorded in
prepaid expenses and other current assets in our Consolidated Balance Sheets. The fair value of
this contract changes based on the change in our stock price compared with the contract exercise
price. We recognized $1 million in income in 2005 and $2 million in income in 2004, resulting from
the change in fair value of these prepaid forward contracts. The earnings impact from these
instruments is classified as selling, delivery and administrative expenses.
Other
Financial Assets and Liabilities — Financial assets with carrying values approximating
fair value include cash and cash equivalents and accounts receivable. Financial liabilities with
carrying values approximating fair value include accounts payable and other accrued liabilities and
short-term debt. The carrying value of these financial assets and liabilities approximates fair
value due to their short maturities and since interest rates approximate current market rates for
short-term debt.
Long-term debt at December 31, 2005, had a carrying value and fair value of $4.6 billion and
$4.8 billion, respectively, and at December 25, 2004, had a carrying value and fair value of $4.6
billion and $4.8 billion,
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respectively. The fair value is based on interest rates that are
currently available to us for issuance of debt with similar terms and remaining maturities.
Note 12—Pension and Postretirement Medical Benefit Plans
Pension Benefits
Our U.S. employees participate in noncontributory defined benefit pension plans, which cover
substantially all full-time salaried employees, as well as most hourly employees. Benefits
generally are based on years of service and compensation, or stated amounts for each year of
service. All of our qualified plans are funded and contributions are made in amounts not less than
minimum statutory funding requirements and not more than the maximum amount that can be deducted
for U.S. income tax purposes. Our net pension expense for the defined benefit plans for our
operations outside the U.S. was not significant and is not included in the tables presented below.
Nearly all of our U.S. employees are also eligible to participate in our 401(k) savings plans,
which are voluntary defined contribution plans. We make matching contributions to the 401(k)
savings plans on behalf of participants eligible to receive such contributions. If a participant
has one or more but less than 10 years of eligible service, our match will equal $0.50 for each
dollar the participant elects to defer up to 4 percent of the participant’s pay. If the
participant has 10 or more years of eligible service, our match will equal $1.00 for each dollar
the participant elects to defer up to 4 percent of the participant’s pay.
Postretirement Medical Benefits
Our postretirement medical plans provide medical and life insurance benefits principally to
U.S. retirees and their dependents. Employees are eligible for benefits if they meet age and
service requirements and qualify for retirement benefits. The plans are not funded and since 1993
have included retiree cost sharing. In 2004, we merged our long-term disability medical plan with
our postretirement medical plan. Our long-term disability medical plan was amended to provide
coverage for two years for participants becoming disabled after January 1, 2005. Participants
receiving benefits before January 1, 2005 remain eligible under the existing benefits program which
does not limit benefits to a two-year period. The liabilities and respective costs associated with
these participants have been added to our postretirement medical plan.
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Changes in the Projected Benefit Obligations
Changes in the Fair Value of Assets
Additional Plan Information
The accumulated and projected obligations for all plans exceed the fair value of assets.
Funded Status Recognized on the Consolidated Balance Sheets
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Net Amounts Recognized in the Consolidated Balance Sheets
At December 31, 2005 and December 25, 2004, the accumulated benefit obligation of PBG’s U.S.
pension plans exceeded the fair market value of the plan assets resulting in the recognition of the
unfunded liability as a minimum balance sheet liability. As a result of this additional liability,
our intangible asset increased by $14 million to $64 million in 2005, which equals the amount of
unrecognized prior service cost in our plans. The remainder of the liability that exceeded the
unrecognized prior service cost was recognized as an increase to accumulated other comprehensive
loss of $8 million and $29 million in 2005 and 2004, respectively, before taxes and minority
interest. The adjustments to accumulated other comprehensive loss are reflected after minority
interest of $1 million and $2 million, and deferred income taxes of $2 million and $11 million in
2005 and 2004, respectively, in our Consolidated Statements of Changes in Shareholders’ Equity.
Assumptions
The weighted-average assumptions used to measure net expense for years ended:
The weighted-average assumptions used to measure the benefit liability as of the end of the
year were as follows:
We have evaluated these assumptions with our actuarial advisors and we believe that they are
appropriate, although an increase or decrease in the assumptions or economic events outside our
control could have a material impact on reported net income.
Funding and Plan Assets
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The table above shows the target allocation and actual allocation. Our target allocations of
our plan assets reflect the long-term nature of our pension liabilities. None of the assets are
invested directly in equity or debt instruments issued by PBG, PepsiCo or any bottling affiliates
of PepsiCo, although it is possible that insignificant indirect investments exist through our broad
market indices. Our equity investments are diversified across all areas of the equity market
(i.e., large, mid and small capitalization stocks as well as international equities). Our fixed
income investments are also diversified and consist of both corporate and U.S. government bonds. We
currently do not invest directly into any derivative investments. PBG’s assets are held in a
pension trust account at our trustee’s bank.
PBG’s pension investment policy and strategy are mandated by PBG’s Pension Investment
Committee (“PIC”) and are overseen by the PBG Board of Directors’ Compensation and Management
Development Committee. The plan assets are invested using a combination of enhanced and passive
indexing strategies. The performance of the plan assets is benchmarked against market indices and reviewed by the PIC. Changes in
investment strategies, asset allocations and specific investments are approved by the PIC prior to
execution.
Health Care Cost Trend Rates
We have assumed an average increase of 9.0 percent in 2006 in the cost of postretirement
medical benefits for employees who retired before cost sharing was introduced. This average
increase is then projected to decline gradually to 5.0 percent in 2013 and thereafter.
Assumed health care cost trend rates have an impact on the amounts reported for postretirement
medical plans. A one-percentage point change in assumed health care costs would have the following
impact:
On May 19, 2004, the FASB issued Staff Position No. FAS 106-2 to provide guidance relating to
the prescription drug subsidy provided by the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (“Act”). The prescription drug benefits currently provided to all our
Medicare-eligible retirees would be considered actuarially equivalent to the benefit provided under
the Act based on the guidance issued by the Centers for Medicare & Medicaid Services.
For the years ended 2005 and 2004, the net periodic postretirement medical benefits cost
decreased by $1.7 million and $1.1 million, respectively as a result of the Act.
In addition, the Obligation (accumulated projected benefit obligation) as of year end 2005 and
2004 decreased by $14.8 million and $14.3 million, respectively as a result of the Act.
There were no changes in estimates of participation or per-capita claims costs as a result of
the Act.
Pension and Postretirement Cash Flow
Our contributions are made in accordance with applicable tax regulations that provide us with
current tax deductions for our contributions and for taxation to the employee when the benefits are
received. We do not fund our pension plan and postretirement medical plans when our contributions
would not be tax deductible or when benefits would be taxable to the employee before receipt. Of
the total pension liabilities at December 31, 2005, $52 million relates to plans not funded due to
these unfavorable tax consequences.
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Our 2006 expected contributions are intended to meet or exceed the IRS minimum
requirements and provide us with current tax deductions.
Expected Benefit Payments
The expected benefit payments made from our pension and postretirement medical plans (with and
without the subsidy received from the Act) to our participants over the next ten years are as
follows:
Note 13—Stock-Based Compensation Plans
Under our stock-based long-term incentive compensation plans (“incentive plan”) we grant
non-qualified stock options to certain employees, including middle and senior management. We also
grant restricted stock and restricted stock units to certain senior executives. Non-employee
members of our Board (“Directors”) participate in a separate incentive plan. Directors receive a
one-time restricted stock award of $25,000 upon commencing service on our Board and, each year
while serving as a Director, each Director is granted an equity-based award, which may include
non-qualified stock options, shares of common stock or restricted stock.
Beginning
in 2006, under our incentive plans an equal mix of stock options and restricted stock
units will be granted to Directors and middle and senior management employees.
Restricted Stock and Restricted Stock Units
Restricted stock and restricted stock units granted to employees have vesting periods that
range from two to five years. In addition, restricted stock unit awards to certain senior
executives contain vesting provisions that are contingent upon the achievement of pre-established
performance targets. The initial restricted stock award to Directors remains restricted while the
individual serves on the Board. The annual grants to Directors are immediately vested, but may be
deferred. All restricted stock and restricted stock unit awards are settled in shares of PBG
common stock.
Upon issuance of restricted stock or restricted stock units, unearned compensation is
recognized within shareholders’ equity for the cost of the stock or units. The unearned
compensation is recognized as compensation expense ratably over the vesting period of the award.
The following table summarizes restricted stock and restricted stock unit activity for the
years ended 2005, 2004, and 2003:
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Stock Options
Options
granted in 2005, 2004 and 2003 had exercise prices ranging from $27.75 per share to
$29.75 per share, $24.25 per share to $30.25 per share and $18.25 per share to $25.50 per share,
respectively, expire in 10 years and generally become exercisable 25 percent after one year, an
additional 25 percent after two years, and the remainder after three years. We measure the fair
value of our options on the date of grant using the Black-Scholes-Merton option-pricing model.
The following table summarizes option activity during 2005:
The following table summarizes option activity during 2004:
The following table summarizes option activity during 2003:
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Stock options outstanding and exercisable at December 31, 2005:
Note 14—Income Taxes
The details of our income tax provision are set forth below:
In 2005, our tax provision includes increased taxes on U.S. earnings and additional
contingencies related to certain historic tax positions, as well as the following significant
items:
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In 2004, we had the following significant tax items, which decreased our tax expense by
approximately $4 million:
Our 2003 income tax provision includes an increase in income tax expense of $11 million due to
enacted tax rate changes in Canada during the 2003 tax year.
Our U.S. and foreign income before income taxes is set forth below:
Our reconciliation of income taxes calculated at the U.S. federal statutory rate to our
provision for income taxes is set forth below:
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The details of our 2005 and 2004 deferred tax liabilities (assets) are set forth below:
We have net operating loss carryforwards (“NOLs”) totaling $1,146 million at December 31,
2005, which are available to reduce future taxes in the U.S., Spain, Greece, Russia, Turkey and
Mexico. Of these NOLs, $6 million expire in 2006 and $1,140 million expire at various times between
2007 and 2025. At December 31, 2005, we have tax credit carryforwards in the U.S. of $4 million
with an indefinite carryforward period and in Mexico of $14 million, which expires at various times
between 2009 and 2015.
We establish valuation allowances for our deferred tax assets when the amount of expected
future taxable income is not likely to support the use of the deduction or credit. Our valuation
allowances, which reduce deferred tax assets to an amount that will more likely than not be
realized, decreased by $92 million in 2005 and increased by $49 million in 2004.
Approximately $17 million of our valuation allowance relating to our deferred tax assets at
December 31, 2005, would be applied to reduce goodwill if reversed in future periods.
Deferred taxes are not recognized for temporary differences related to investments in foreign
subsidiaries that are essentially permanent in duration. Determination of the amount of
unrecognized deferred taxes related to these investments is not practicable. The undistributed
earnings and profits of our foreign subsidiaries were approximately $564 million at December 31,
2005. The American Jobs Creation Act of 2004 provides a special tax deduction for the repatriation
in either 2004 or 2005 of earnings and profits from foreign subsidiaries. We evaluated this
special tax deduction and, based on the facts surrounding our foreign operations, decided not to
repatriate any of our undistributed foreign earnings and profits pursuant to this deduction.
Income taxes receivable from taxing authorities were $39 million and $50 million at December
31, 2005 and December 25, 2004, respectively. Such amounts are recorded within prepaid expenses
and other current assets and other long-term assets in our Consolidated Balance Sheets. Income
taxes payable to taxing authorities were $34 million and $17 million at December 31, 2005 and
December 25, 2004, respectively. Such amounts are recorded within accounts payable and other
current liabilities in our Consolidated Balance Sheets.
Income taxes receivable from related parties were $4 million and $5 million at December 31,
2005 and December 25, 2004, respectively. Such amounts are recorded within accounts receivable in
our Consolidated Balance Sheets. Amounts paid to taxing authorities and related parties for income
taxes were $235 million, $172 million and $115 million in 2005, 2004 and 2003 respectively.
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Under our tax separation agreement with PepsiCo, PepsiCo maintains full control and absolute
discretion for any combined or consolidated tax filings for tax periods ended on or before our
initial public offering that occurred in March 1999. PepsiCo has contractually agreed to act in
good faith with respect to all tax examination matters affecting us. In accordance with the tax
separation agreement, we will bear our allocable share of any risk or benefit resulting from the
settlement of tax matters affecting us for these periods.
Note 15—Geographic Data
We operate in one industry, carbonated soft drinks and other ready-to-drink beverages. We
conduct business in the U.S., Mexico, Canada, Spain, Russia, Greece and Turkey.
Note 16—Related Party Transactions
PepsiCo is considered a related party due to the nature of our franchise relationship and its
ownership interest in our company. The most significant agreements that govern our relationship
with PepsiCo consist of:
Additionally, we review our annual marketing, advertising, management and financial plans each
year with PepsiCo for its approval. If we fail to submit these plans, or if we fail to carry them
out in all material respects, PepsiCo can terminate our beverage agreements. If our beverage
agreements with PepsiCo are terminated for this or for any other reason, it would have a material
adverse effect on our business and financial results.
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The Consolidated Statements of Operations include the following income (expense) amounts as a
result of transactions with PepsiCo and its affiliates:
(a) Bottler Incentives and Other Arrangements — In order to promote PepsiCo beverages,
PepsiCo, at its discretion, provides us with various forms of bottler incentives. These incentives
cover a variety of initiatives, including direct marketplace support and advertising support. We
record most of these incentives as an adjustment to cost of sales unless the incentive is for
reimbursement of a specific, incremental and identifiable cost. Under these conditions, the
incentive would be recorded as an offset against the related costs, either in revenue or selling,
delivery and administrative expenses. Changes in our bottler incentives and funding levels could
materially affect our business and financial results.
(b) Purchase of Concentrate and Finished Product — As part of our franchise relationship, we
purchase concentrate from PepsiCo, pay royalties and produce or distribute other products through
various arrangements with PepsiCo or PepsiCo joint ventures. The prices we pay for concentrate,
finished goods and royalties are determined by PepsiCo at its sole discretion. Concentrate prices
are typically determined annually. In February 2005, PepsiCo increased the price of U.S.
concentrate by two percent. PepsiCo has recently announced a further increase of approximately two
percent, effective February 2006. Significant changes in the amount we pay PepsiCo for
concentrate, finished goods and royalties could materially affect our business and financial
results. These amounts are reflected in cost of sales in our Consolidated Statements of Operations.
(c) Manufacturing
and Distribution Service Reimbursements — In 2003, we provided manufacturing
services to PepsiCo and PepsiCo affiliates in connection with the production of certain finished
beverage products.
(d) Fountain
Service Fee — We manufacture and distribute fountain products and provide
fountain equipment service to PepsiCo customers in some territories in accordance with the Pepsi
beverage agreements. Amounts
received from PepsiCo for these transactions are offset by the cost to provide these services
and are reflected in our Consolidated Statements of Operations in selling, delivery and
administrative expenses.
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(e) Frito-Lay Purchases — We purchase snack food products from Frito-Lay, Inc., a subsidiary
of PepsiCo, for sale and distribution in Russia. Amounts paid to PepsiCo for these transactions are
reflected in selling, delivery and administrative expenses in our Consolidated Statements of
Operations.
(f) Shared
Services — We provide to and receive various services from PepsiCo and PepsiCo
affiliates pursuant to a shared services agreement and other arrangements. In the absence of
these agreements, we would have to obtain such services on our own. We might not be able to obtain
these services on terms, including cost, which are as favorable as those we receive from PepsiCo.
Total expenses incurred and income generated is reflected in selling, delivery and administrative
expenses in our Consolidated Statements of Operations.
(g) Income
Tax Benefit — Under our tax separation agreement with PepsiCo, PepsiCo maintains
full control and absolute discretion for any combined or consolidated tax filings for tax periods
ended on or before our initial public offering that occurred in March 1999. PepsiCo has
contractually agreed to act in good faith with respect to all tax examination matters affecting us.
In accordance with the tax separation agreement, we will bear our
allocable share of any risk or
benefit resulting from the settlement of tax matters affecting us for these periods.
(h) High
Fructose Corn Syrup (“HFCS”) Settlement — On June 28, 2005, Bottling Group LLC and PepsiCo entered into a settlement agreement related to
the allocation of certain proceeds from the settlement of the HFCS class action lawsuit. The
lawsuit related to purchases of high fructose corn syrup by several companies, including bottling
entities owned and operated by PepsiCo, during the period from July 1, 1991 to June 30, 1995 (the
“Class Period”). Certain of the bottling entities owned by PepsiCo were transferred to PBG when
PepsiCo formed PBG in 1999 (the “PepsiCo Bottling Entities”). Under the settlement agreement with
PepsiCo, the Company ultimately received 45.8 percent (or approximately $23 million) of the total
recovery related to HFCS purchases by PepsiCo Bottling Entities during the Class Period.
We are not required to pay any minimum fees to PepsiCo, nor are we obligated to PepsiCo under
any minimum purchase requirements.
We paid PepsiCo $1 million and $3 million during 2004 and 2003, respectively, for distribution
rights relating to the SoBe brand in certain PBG-owned territories in the U.S. and Canada.
Bottling Group, LLC will distribute pro rata to PepsiCo and PBG, based upon membership
interest, sufficient cash such that aggregate cash distributed to us will enable us to pay our
income taxes and interest on our $1 billion 7.0% senior notes due 2029. PepsiCo’s pro-rata cash
distribution during 2005, 2004 and 2003 from Bottling Group, LLC was $12 million, $13 million and
$7 million, respectively.
As of December 31, 2005 and December 25, 2004, the receivables from PepsiCo and its affiliates
were $143 million and $150 million, respectively. These balances are shown as part of accounts
receivable in our Consolidated Financial Statements. The payables to PepsiCo and its affiliates
were $176 million and $144 million, respectively. These balances are shown as part of accounts
payable and other current liabilities in our Consolidated Financial Statements.
Two of our board members are employees of PepsiCo. Neither of these board members serves on
our Audit and Affiliated Transactions Committee, Compensation and Management Development Committee
or Nominating and Corporate Governance Committee. In addition, one of the managing directors of
Bottling Group, LLC, our principal operating subsidiary, is an employee of PepsiCo.
Note 17—Contingencies
We are subject to various claims and contingencies related to lawsuits, taxes, environmental
and other matters arising out of the normal course of business. We believe that the ultimate
liability arising from such claims or contingencies, if any, in excess of amounts already
recognized is not likely to have a material adverse effect on our results of operations, financial
condition or liquidity.
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Note 18—Acquisitions
In September 2005, we acquired the operations and exclusive right to manufacture, sell and
distribute Pepsi-Cola beverages from the Pepsi-Cola Bottling Company of Charlotte, North Carolina.
The acquisition did not have a material impact on our Consolidated Financial Statements.
As a result of the acquisition, we have assigned $70 million to goodwill, $118 million to
franchise rights and $12 million to non-compete arrangements. The goodwill and franchise rights
are not subject to amortization. The non-compete agreements are being amortized over ten years. The
allocations of the purchase price for the acquisition are still preliminary and will be determined
based on the estimated fair value of assets acquired and liabilities assumed as of the date of the
acquisition. The operating results of the acquisition are included in the accompanying consolidated
financial statements from its date of purchase. The acquisition was made to enable us to provide
better service to our large retail customers. We expect the acquisition to reduce costs through
economies of scale.
During 2004, we acquired the operations and exclusive right to manufacture, sell and distribute
Pepsi-Cola beverages from four franchise bottlers. The following acquisitions occurred for an
aggregate purchase price of $95 million in cash and assumption of liabilities of $22 million:
As a result of these acquisitions, we have assigned $5 million to goodwill, $66 million to
franchise rights and $3 million to non-compete arrangements. The goodwill and franchise rights are
not subject to amortization. The non-compete agreements are being amortized over five to ten years.
During 2004, we also paid $1 million for the purchase of certain distribution rights relating
to SoBe.
Note
19 — Accumulated Other Comprehensive Loss
The year-end balances related to each component of accumulated other comprehensive loss were
as follows:
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Note 20—Computation of Basic and Diluted Earnings Per Share
(shares in thousands)
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