1
EXHIBIT 13
MANAGEMENT'S FINANCIAL REVIEW
OVERVIEW
- --------
The Pepsi Bottling Group, Inc. (collectively referred to as "PBG," "we,"
"our" and "us") became a public company through an initial public offering of
100,000,000 shares on March 31, 1999, marking our separation from PepsiCo, Inc.
and our beginning as a company focused solely on the bottling business. As an
independent bottling company, we set objectives aimed at profitably growing our
business and building shareholder value. We are proud to report that we have
exceeded our goals for 1999:
- We delivered 13% constant territory EBITDA growth in 1999,
significantly higher than the 8-10% growth target we had set for
ourselves at the time of our initial public offering.
- We generated $161 million of operating cash flow in 1999, exceeding
our original projections by approximately $200 million.
- We delivered $0.71 in earnings per share, an increase of $0.54 over
1998 after adjusting for one-time items and the number of shares
outstanding.
- We made 142,000 net placements of cold drink equipment in North
America, approximately 36,000 pieces ahead of prior year.
- We increased our return on invested capital by 1% in 1999.
- We made six acquisitions during the year for approximately $185
million in cash and assumed debt, increasing our share of
Pepsi-Cola's North American market approximately 1% to more than
55%.
The following discussion and analysis covers the key drivers behind our
success in 1999 and is broken down into five major sections. The first two
sections provide an overview and focus on items that affect the comparability of
historical or future results. The next two sections provide an analysis of our
results of operations and liquidity and financial condition. The last section
contains a discussion of our market risks and cautionary statements. The
discussion and analysis throughout management's financial review should be read
in conjunction with the Consolidated Financial Statements and the related
accompanying notes.
25
2
Constant Territory
We believe that constant territory performance results are the most
appropriate indicators of operating trends and performance, particularly in
light of our stated intention of acquiring additional bottling territories, and
are consistent with industry practice. Constant territory operating results are
achieved by adjusting current year results to exclude current year acquisitions
and adjusting prior year results to include the results of prior year
acquisitions as if they had occurred on the first day of the prior fiscal year.
Constant territory results also exclude any unusual impairment and other charges
and credits.
Use of EBITDA
EBITDA, which is computed as operating income plus the sum of depreciation
and amortization, is a key indicator management and the industry use to evaluate
operating performance. It is not, however, required under generally accepted
accounting principles and should not be considered an alternative to
measurements required by GAAP such as net income or cash flows. In addition,
EBITDA for 1999 and 1998 excludes the impact of the non-cash portion of the
unusual impairment and other charges and credits discussed below and in Note 4
of the Consolidated Financial Statements.
ITEMS THAT AFFECT HISTORICAL OR FUTURE COMPARABILITY
- ----------------------------------------------------
Initial Public Offering
PBG was incorporated in Delaware in January 1999 and, prior to our
formation, we were an operating unit of PepsiCo. Our initial public offering
consisted of 100,000,000 shares of common stock sold to the public, equivalent
to 65% of our outstanding common stock, leaving PepsiCo the owner of the
remaining 35% of outstanding common stock. PepsiCo's ownership has increased to
36.7% as a result of net repurchases of 5.3 million shares under our share
repurchase program. In addition, in conjunction with our initial public
offering, PBG and PepsiCo contributed bottling businesses and assets used in the
bottling businesses to Bottling Group, LLC, our principal operating subsidiary.
As a result of the contribution of these assets, PBG owns 92.9% of Bottling
Group, LLC and PepsiCo owns the remaining 7.1%, giving PepsiCo economic
ownership of 41.2% of our combined operations. We fully consolidate the results
of Bottling Group, LLC and present PepsiCo's share as minority interest in our
Consolidated Financial Statements.
For the periods prior to our initial public offering we prepared our
Consolidated Financial Statements as a "carve-out" from the financial statements
of PepsiCo using the historical results of operations and assets and liabilities
of our business. Certain costs reflected in the Consolidated Financial
Statements may not necessarily be indicative of the costs that we would have
incurred had we operated as an independent, stand-alone entity for all periods
presented. These costs include an allocation of PepsiCo corporate overhead and
interest expense, and income taxes:
- We included corporate overhead related to PepsiCo's corporate
administrative functions based on a specific identification of
PepsiCo's administrative costs relating to the bottling operations
and, to the extent that such identification was not practicable,
based upon the percentage of our revenues to PepsiCo's consolidated
net revenues. These costs are included in selling, delivery and
administrative expenses in our Consolidated Statements of
Operations.
- We allocated $3.3 billion of PepsiCo debt to our business and
charged interest expense on this debt using PepsiCo's
weighted-average interest rate. Once we issued $3.3 billion of
third-party debt in the first quarter of 1999, our actual interest
rates were used to determine interest expense for the remainder of
the year.
- We reflected income tax expense in the Consolidated Financial
Statements as if we had actually filed a separate income tax
return.
The amounts, by year, of the historical allocations described above are as
follows:
1999* 1998 1997
----- ---- ----
dollars in millions
Corporate overhead expense........................... $ 3 $ 40 $ 42
Interest expense..................................... $ 28 $210 $205
PepsiCo weighted-average interest rate............... 5.8% 6.4% 6.2%
* Prior to our initial public offering.
26
3
Unusual Impairment and Other Charges and Credits
Our operating results were affected by the following unusual charges and credits
in 1999 and 1998:
1999 1998*
---- -----
dollars in millions
Non-cash compensation charge .............. $ 45 $ --
Vacation policy change .................... (53) --
Asset impairment and restructuring charges (8) 222
----- -----
$ (16) $ 222
===== =====
After minority interest and income taxes $ (9) $ 218
===== =====
* Does not include tax settlement with the Internal Revenue Service
discussed on this page.
- - Non-cash Compensation Charge
In connection with the completion of our initial public offering,
PepsiCo vested substantially all non-vested PepsiCo stock options held by
PBG employees. As a result, we incurred a $45 million non-cash compensation
charge in the second quarter of 1999, equal to the difference between the
market price of the PepsiCo capital stock and the exercise price of these
options at the vesting date.
- - Vacation Policy Change
As a result of changes to our employee benefit and compensation plans,
employees will now earn vacation time evenly throughout the year based upon
service rendered. Previously, employees were fully vested at the beginning
of each year. As a result of this change, we have reversed an accrual of
$53 million into income.
- - Asset Impairment and Restructuring Charges
In the fourth quarter of 1998, we recorded $222 million of charges
relating to the following:
- A charge of $212 million for asset impairment of $194 million
and other charges of $18 million related to restructuring our
Russian operations.
- A charge of $10 million for employee-related and other costs,
mainly relocation and severance, resulting from the separation
of Pepsi-Cola bottling and concentrate organizations.
In the fourth quarter of 1999, $8 million of the remaining 1998
restructuring reserves was reversed into income, as actual costs incurred
to renegotiate manufacturing and leasing contracts in Russia and to reduce
the number of employees were less than the amounts originally estimated.
- - Tax Settlement with the Internal Revenue Service
In 1998, we settled a dispute with the Internal Revenue Service
regarding the deductibility of the amortization of acquired franchise
rights, resulting in a $46 million tax benefit.
Comparability of our operating results may also be affected by the following:
Concentrate Supply
We buy concentrate, the critical flavor ingredient for our products, from
PepsiCo, its affiliates and other brand owners who are the sole authorized
suppliers. Concentrate prices are typically determined annually.
In February 1999, PepsiCo announced an increase of approximately 5% in the
price of U.S. concentrate. The cost of this increase was offset in substantial
part with increases in the level of marketing support and funding we received
from PepsiCo. PepsiCo has recently announced a further increase of approximately
7%, effective February 2000, which will be available for use by PepsiCo to
support brand-building initiatives aimed at driving volume. Amounts paid or
payable to PepsiCo and its affiliates for concentrate were $1,418 million,
$1,283 million and $1,135 million in 1999, 1998 and 1997, respectively.
Bottler Incentives
PepsiCo and other brand owners provide us with various forms of marketing
support. The level of this support is negotiated annually and can be increased
or decreased at the discretion of the brand owners. This marketing support is
intended to cover a variety of programs and initiatives, including direct
marketplace support, capital equipment funding and shared media and advertising
support. Direct marketplace support is primarily funding by PepsiCo and other
brand owners of sales discounts and similar programs, and is recorded as an
adjustment to net revenues. Capital equipment funding is designed to support the
purchase and placement of marketing equipment and is recorded as a reduction to
selling, delivery and administrative expenses. Shared media and advertising
support is recorded as a
27
4
reduction to advertising and marketing expense within selling, delivery and
administrative expenses.
The total bottler incentives we received from PepsiCo and other brand
owners were $563 million, $536 million and $463 million for 1999, 1998 and 1997,
respectively. Of these amounts, we recorded $263 million, $247 million and $235
million for 1999, 1998 and 1997, respectively, in net revenues, and the
remainder as a reduction to selling, delivery and administrative expenses. The
amount of our bottler incentives received from PepsiCo was more than 90% of our
total bottler incentives in each of the three years, with the balance received
from the other brand owners. We negotiate the level of funding with PepsiCo and
other brand owners as part of the annual planning process.
Our Investment in Russia
In recent years, we have invested in Russia to build infrastructure and to
fund start-up manufacturing and distribution costs. During the first half of
1998, our volumes were growing at approximately 50% over 1997 levels. However,
following the August 1998 devaluation of the ruble, we experienced a significant
drop in demand, resulting in lower net revenues and increased operating losses.
As a result of the economic crisis and the under-utilization of assets, we
incurred a charge of $212 million in the fourth quarter of 1998 to write down
our assets and reduce our fixed-cost structure. The economic conditions in 1999
have been more stable. However, volumes and revenues have not yet returned to
levels achieved immediately prior to the devaluation as Russian consumers have
switched from branded products to lower-cost alternatives. In response to this
environment, we have focused on developing alternative means of leveraging our
existing asset base while significantly reducing costs. Most notably, we have
begun to distribute Frito-Lay(R) snack products throughout all of Russia, except
Moscow. In addition, we have recently launched our own value brand beverage
products.
We anticipate that our Russian operations will continue to incur losses and
require cash to fund operations for at least the fiscal year 2000. However,
capital requirements will be minimal because our existing infrastructure is
adequate for current operations. Cash requirements for investing activities and
to fund operations were $45 million, $156 million and $71 million in 1999, 1998
and 1997, respectively. Volume in Russia accounted for 1%, 2% and 1% of our
total volume in 1999, 1998 and 1997, respectively. We will continue to review
our Russian operations on a regular basis and to consider changes in our
distribution systems and other operations as circumstances dictate.
Employee Benefit Plan Changes
We are making several changes to our employee benefit plans that will take
effect in fiscal year 2000. Our objective is to ensure that the overall
compensation and benefit plans offered to our employees are competitive with our
industry. The changes that have been made to our vacation policy, pension and
retiree medical plans include some benefit enhancements as well as cost
containment provisions. We do not believe that the net impact of these changes
will be material to our financial results in fiscal year 2000.
In addition, as previously disclosed at the time of our initial public
offering, we are not continuing the broad-based stock option program provided by
PepsiCo. In its place our Board of Directors has approved a matching company
contribution to our 401(k) plan to begin in 2000. The match will be made in PBG
stock and the amount will depend upon the employee's contribution and years of
service. We anticipate that the matching company contribution will cost
approximately $12 million in fiscal year 2000.
Finally, in the fourth quarter of 1999 we recognized a $16 million
compensation charge related to full-year 1999 performance. This expense is
one-time in nature and is for the benefit of our management employees,
reflecting our successful operating results as well as providing certain
incentive-related features.
Fiscal Year
Our fiscal year ends on the last Saturday in December and, as a result, a
fifty-third week is added every five or six years. Fiscal years 1999, 1998 and
1997 consisted of 52 weeks. Fiscal year 2000 will have 53 weeks.
28
5
THE PEPSI BOTTLING GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in millions, except per share data)
Fiscal years ended December 25, 1999, December 26, 1998 and December 27, 1997
1999 1998 1997
---- ---- ----
NET REVENUES ........................................ $ 7,505 $ 7,041 $ 6,592
Cost of sales ....................................... 4,296 4,181 3,832
------- ------- -------
GROSS PROFIT ........................................ 3,209 2,860 2,760
Selling, delivery and administrative expenses ....... 2,813 2,583 2,425
Unusual impairment and other charges and credits .... (16) 222 --
------- ------- -------
OPERATING INCOME .................................... 412 55 335
Interest expense, net ............................... 202 221 222
Foreign currency loss (gain) ........................ 1 26 (2)
Minority interest ................................... 21 -- --
------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES ................... 188 (192) 115
Income tax expense (benefit) ........................ 70 (46) 56
------- ------- -------
NET INCOME (LOSS) ................................... $ 118 $ (146) $ 59
======= ======= =======
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE ......... $ 0.92 $ (2.65) $ 1.07
WEIGHTED-AVERAGE BASIC AND DILUTED SHARES OUTSTANDING 128 55 55
See accompanying notes to Consolidated Financial Statements.
Management's Financial Review
RESULTS OF OPERATIONS
- ---------------------
FISCAL 1999 VS. 1998 FISCAL 1998 VS. 1997
-------------------- --------------------
CONSTANT CONSTANT
REPORTED TERRITORY REPORTED TERRITORY
CHANGE CHANGE CHANGE CHANGE
------ ------ ------ ------
EBITDA................................ 25% 13% (7)% 0%
Volume................................ 4% 0% 7 % 5%
Net Revenue per Case.................. 3% 3% (1)% 0%
EBITDA
Reported EBITDA was $901 million in 1999, representing a 25% increase over
1998. On a constant territory basis, EBITDA growth of 13% was driven by a strong
pricing environment particularly in the U.S. take-home segment, solid volume
growth in our higher-margin cold drink segment and reduced operating losses in
Russia.
In 1998, EBITDA declined 7% on a reported basis and was flat on a constant
territory basis. Strong volume gains were more than offset by higher raw
material costs in North America, increased selling and delivery expenses
associated with our investment in the cold drink segment and higher losses in
our Russian operations. The reported decline in 1998 was also impacted by $28
million of cash restructuring charges.
VOLUME
Our worldwide raw case volume grew 4% on a reported basis in 1999, and was
flat on a constant territory basis. Raw cases are physical cases sold,
regardless of the volume contained in these cases. In North America, which
consists of the U.S. and Canada, constant territory volume improved 1%. Growth
in our cold drink segment was offset by declines in the take-home business as we
raised prices in the take-home segment. Outside North America, our constant
territory volumes declined 6%, driven by the continued impact of the economic
conditions in Russia, which began to deteriorate in August 1998 with the
devaluation of the ruble.
In 1998, worldwide case volume grew 7% compared to 1997, with North America
increasing 6% and countries outside North America increasing 18%. Constant
territory volume increased 5% in the North American markets, 6% outside North
America and 5% worldwide. North American results were driven by solid growth in
our cold drink segment, modest gains in the take-home segment and the favorable
impact of the launch of Pepsi ONE in the fourth quarter of 1998. Constant
territory volume growth outside North America was positive in all of our
markets, led by Russia, which increased 21%.
29
6
NET REVENUES
On a reported basis, net revenues were $7,505 million in 1999, representing
a 7% increase over 1998. On a constant territory basis, net revenues increased
3%, with increases in North America offsetting a revenue decline outside North
America. North American constant territory growth was driven by a 1% increase in
volume and a 4% increase in net revenue per case. The net revenue per case
increase was driven by strong pricing, led by advances in the take-home segment
and an increased mix of higher-revenue cold drink volume. Initial volume
declines partially offset the revenue impact of higher take-home pricing,
although volumes rebounded in the fourth quarter of 1999. Outside North
America, revenue declines were impacted by the August 1998 ruble devaluation in
Russia. On a worldwide basis, constant territory revenue per physical case was
up 3%.
Worldwide net revenues grew 7% from 1997 to 1998 on a reported basis and
5% on a constant territory basis. Volume gains contributed five percentage
points to constant territory revenue growth while pricing remained essentially
flat. Flat pricing reflected an increased mix of higher-priced single-serve
cold drink packages sold, offset by lower take-home package pricing in North
American markets, and promotional pricing relating to the U.S. introduction of
Pepsi ONE in the fourth quarter of 1998.
COST OF SALES
Cost of sales as a percentage of net revenues decreased from 59.4% in 1998
to 57.3% in 1999. This trend was driven by higher net revenue per case and
relatively flat cost of sales per case as higher concentrate prices were offset
by lower packaging costs and the favorable effect of renegotiating our raw
material contracts in Russia to a ruble denomination instead of U.S. dollars.
Cost of sales as a percentage of net revenues increased from 58.1% in 1997
to 59.4% in 1998. This increase was primarily a result of margin declines in the
take-home segment and increases in concentrate costs. An increased mix of
revenues in the higher-margin cold drink segment in 1998 was insufficient to
offset margin declines in the take-home segment.
SELLING, DELIVERY AND ADMINISTRATIVE EXPENSES
Selling, delivery and administrative expenses increased $230 million, or
9%, in 1999. This increase was driven by acquisitions and higher selling and
delivery costs, which resulted from our continued investment in our North
American cold drink infrastructure. Additional headcount, delivery routes and
depreciation increases resulted from this initiative in 1999. We anticipate that
the investments we are making in the cold drink business will be more than
recovered through the resulting revenue growth in this higher-margin business.
In addition, higher advertising and marketing spending was offset by reduced
operating costs in Russia, as our cost structure benefited from our fourth
quarter 1998 restructuring actions. Administrative costs were impacted by
increased performance-related compensation due to our stronger operating results
in 1999 compared to 1998. Excluding the impact of performance-related
compensation, our administrative costs were relatively flat year-over-year.
In 1998, selling, delivery and administrative expenses increased $158
million, or 7%. Selling and delivery costs grew at a rate faster than volume
while our other administrative costs grew less than 1% in 1998. The costs
associated with selling and delivery grew faster than volume largely because of
our heavy investment in vending machines and coolers, consistent with our
long-term strategy to increase our presence in the cold drink segment of the
industry in North America. Spending on vending machines and coolers at customer
locations in the North American markets was approximately 20% higher in 1998
than in 1997, driving increases in the costs associated with placing,
depreciating and providing service for these assets.
FOREIGN CURRENCY EXCHANGE GAINS/LOSSES
Our foreign currency exchange gains and losses arise from our operations in
Russia. Since Russia is considered a highly inflationary economy for accounting
purposes, we are required to remeasure the net monetary assets of our Russian
operations in U.S. dollars and reflect any resulting gain or loss in the
Consolidated Statements of Operations. The August 1998 devaluation of the
Russian ruble resulted in a significant foreign exchange loss in 1998. In 1999,
foreign exchange losses have been minimized due to a more stable ruble exchange
rate.
30
7
INTEREST EXPENSE, NET
Net interest expense decreased by $19 million to $202 million in 1999, due
primarily to a lower average interest rate on PBG's $3.3 billion of long-term
debt. Our average interest rate decreased from 6.4% in 1998, when we used
PepsiCo's average interest rate, to 6.1% in the current year when we issued our
own debt in the first quarter of 1999. Our lower 1999 interest rates reflect
market conditions at the time we issued our debt. In addition, we had reduced
levels of external debt outside North America.
In 1998, interest expense decreased $1 million compared to 1997, reflecting
higher interest income in Spain, offset by an increase in PepsiCo's average
borrowing rate from 6.2% to 6.4%.
PROVISION FOR INCOME TAXES
Our full-year effective tax rate for 1999 was an expense of 37.4%, compared
to a benefit of 24.0% in 1998 and an expense of 48.7% in 1997. In 1999, the
impact of non-deductible goodwill and other expenses on the effective tax rate
was offset in part by lower tax rates in our markets outside the U.S., and by
higher overall pre-tax income. In 1998, we settled a dispute with the Internal
Revenue Service regarding the deductibility of the amortization of acquired
franchise rights, resulting in a $46 million tax benefit in the fourth quarter.
Also in 1998, our effective tax rate was increased due to the unusual charges
relating to Russia restructuring and asset write-offs for which we did not
recognize a tax benefit. The 1997 tax rate was driven by the effect of
non-deductible goodwill and other expenses, offset in part by lower tax rates
outside the U.S.
Our effective tax rate, excluding the unusual impairment and other charges
and credits, would have been 38.0%, 0.9% and 48.7% in 1999, 1998 and 1997,
respectively.
EARNINGS PER SHARE
1999 1998 1997
---- ---- ----
Earnings (loss) per share on reported net income (loss)....... $0.92 $(2.65) $1.07
Average shares outstanding (millions)......................... 128 55 55
Our historical capital structure is not representative of our current
structure due to our initial public offering. In 1999, immediately preceding the
offering, and in 1998 and 1997, we had 55 million shares of common stock
outstanding. In connection with the offering, we sold 100,000,000 shares of
common stock to the public and used the $2.2 billion of proceeds to repay
obligations to PepsiCo and to fund acquisitions.
The table below sets forth earnings per share adjusted for the initial
public offering and the impact of our unusual impairment and other charges and
credits as previously discussed. In 1999, we assumed 155 million shares were
outstanding from the beginning of the year and adjusted for our share repurchase
program, which began in October and under which we made net repurchases of
approximately 5.3 million shares. Similarly, the 1998 and 1997 earnings per
share amounts in the table below have been adjusted, assuming 155 million shares
had been outstanding for the entire period presented.
1999 1998 1997
---- ---- ----
Earnings (loss) per share on reported net income (loss) $ 0.76 $ (0.94) $ 0.38
Unusual impairment and other charges and credits .......... (0.05) 1.41 --
Tax settlement ............................................ -- (0.30) --
------- ------- -------
Adjusted earnings per share ............................... $ 0.71 $ 0.17 $ 0.38
======= ======= =======
Assumed shares outstanding (millions) ..................... 155 155 155
31
8
THE PEPSI BOTTLING GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
Fiscal years ended December 25, 1999, December 1998 and December 27,1997
1999 1998 1997
------- ------- -----
CASH FLOWS -- OPERATIONS
Net income (loss) .................................... $ 118 $ (146) $ 59
Adjustments to reconcile net income (loss) to net cash
provided by operations:
Depreciation ....................................... 374 351 316
Amortization ....................................... 131 121 123
Non-cash unusual impairment and other charges and
credits........................................... (32) 194 --
Non-cash portion of tax settlement ................. -- (46) --
Deferred income taxes .............................. (27) 47 17
Other non-cash charges and credits, net ............ 141 88 12
Changes in operating working capital, excluding
effects of acquisitions and dispositions:
Trade accounts receivable ........................ (30) 46 26
Inventories ...................................... 3 (25) --
Prepaid expenses, deferred income taxes and other
current assets ................................. 4 8 (54)
Accounts payable and other current liabilities ... 41 39 63
Income taxes payable ............................. (5) (52) (14)
------- ------- -----
Net change in operating working capital ........ 13 16 21
------- ------- -----
NET CASH PROVIDED BY OPERATIONS ...................... 718 625 548
------- ------- -----
CASH FLOWS -- INVESTMENTS
Capital expenditures ................................. (560) (507) (472)
Acquisitions of bottlers and investments in affiliates (176) (546) (49)
Sales of bottling operations and property, plant and
equipment .......................................... 22 31 23
Other, net ........................................... (19) (24) (66)
------- ------- -----
NET CASH USED FOR INVESTMENTS ........................ (733) (1,046) (564)
------- ------- -----
CASH FLOWS -- FINANCING
Short-term borrowings -- three months or less ........ (58) 52 (90)
Proceeds from third-party debt ....................... 3,260 50 3
Replacement of PepsiCo allocated debt ................ (3,300) -- --
Net proceeds from initial public offering ............ 2,208 -- --
Payments of third-party debt ......................... (90) (72) (11)
Dividends paid ....................................... (6) -- --
Treasury stock transactions, net ..................... (90) -- --
Increase (decrease) in advances from PepsiCo ......... (1,750) 340 161
------- ------- -----
NET CASH PROVIDED BY FINANCING ....................... 174 370 63
------- ------- -----
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS ........................................ (5) 1 (1)
------- ------- -----
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . 154 (50) 46
CASH AND CASH EQUIVALENTS -- BEGINNING OF YEAR ....... 36 86 40
------- ------- -----
CASH AND CASH EQUIVALENTS -- END OF YEAR ............. $ 190 $ 36 $ 86
======= ======= =====
SUPPLEMENTAL CASH FLOW INFORMATION
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Liabilities incurred and/or assumed in conjunction
with acquisitions of bottlers .................. $ 65 $ 161 $ 3
======= ======= =====
See accompanying notes to Consolidated Financial Statements.
32
9
THE PEPSI BOTTLING GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share data)
December 25, 1999 and December 26, 1998
1999 1998
------- -------
ASSETS
CURRENT ASSETS
Cash and cash equivalents .................................. $ 190 $ 36
Trade accounts receivable, less allowance of $48 and
$46, in 1999 and 1998, respectively ....................... 827 808
Inventories ................................................ 293 296
Prepaid expenses, deferred income taxes and other
current assets ........................................... 183 178
------- -------
TOTAL CURRENT ASSETS ........................................ 1,493 1,318
Property, plant and equipment, net ......................... 2,218 2,055
Intangible assets, net ..................................... 3,819 3,806
Other assets ............................................... 89 143
------- -------
TOTAL ASSETS ............................................. $ 7,619 $ 7,322
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and other current liabilities ............. $ 924 $ 904
Income taxes payable ....................................... -- 9
Short-term borrowings ...................................... 23 112
------- -------
TOTAL CURRENT LIABILITIES ................................ 947 1,025
Allocation of PepsiCo long-term debt ....................... --- 3,300
Long-term debt due to third parties ........................ 3,268 61
Other liabilities .......................................... 385 367
Deferred income taxes ...................................... 1,178 1,202
Minority interest .......................................... 278 --
Advances from PepsiCo ...................................... -- 1,605
------- -------
TOTAL LIABILITIES............................................. 6,056 7,560
SHAREHOLDERS' EQUITY
Common stock, par value $.01 per share:
Authorized 300 shares, issued 155 shares ................. 2 --
Treasury stock: 5 shares ................................... (90) --
Additional paid-in capital ................................. 1,736 --
Retained earnings .......................................... 138 --
Accumulated other comprehensive loss ....................... (223) (238)
------- -------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ........................ 1,563 (238)
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................ $ 7,619 $ 7,322
======= =======
See accompanying notes to Consolidated Financial Statements.
33
10
LIQUIDITY AND FINANCIAL CONDITION
- ---------------------------------
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Prior to our Separation from PepsiCo and our Initial Public
Offering
We financed our capital investments and acquisitions through cash flow from
operations and advances from PepsiCo prior to our separation from PepsiCo and
our initial public offering. Under PepsiCo's centralized cash management system,
PepsiCo deposited sufficient cash in our bank accounts to meet our daily
obligations, and withdrew excess funds from those accounts. These transactions
are included in advances from PepsiCo in our Consolidated Balance Sheets and
Consolidated Statements of Cash Flows.
Liquidity After our Initial Public Offering
Subsequent to our initial public offering, we have financed our capital
investments and acquisitions substantially through cash flow from operations. We
believe that our future cash flow from operations and borrowing capacity will be
sufficient to fund capital expenditures, acquisitions, dividends and other
working capital requirements.
Financing Transactions
On February 9, 1999, $1.3 billion of 5 5/8% senior notes and $1.0 billion of
5 3/8% senior notes were issued by Bottling Group, LLC and are guaranteed by
PepsiCo. On March 8, 1999, we issued $1 billion of 7% senior notes, which are
guaranteed by Bottling Group, LLC. During the second quarter of 1999, we
executed an interest rate swap converting 3% of our fixed-rate debt to
floating-rate debt.
On March 31, 1999, we offered 100,000,000 shares of PBG common stock for
sale to the public in an underwritten initial public offering generating $2.2
billion of net proceeds.
In April 1999, we entered into a $500 million commercial paper program that
is supported by a credit facility. The credit facility consists of two $250
million components, one of which is one year in duration and the other of which
is five years in duration. There were no borrowings outstanding under this
program at December 25, 1999.
The proceeds from the above financing transactions were used to repay
obligations to PepsiCo and fund acquisitions.
Capital Expenditures
We have incurred and will require capital for ongoing infrastructure,
including acquisitions and investments in developing market opportunities.
- - 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 $560
million, $507 million and $472 million during 1999, 1998 and 1997,
respectively. We believe that capital infrastructure spending will
continue to be significant, driven by our investments in the cold drink
segment.
- - We intend to continue to pursue acquisitions of independent PepsiCo
bottlers in the U.S. and Canada, particularly in territories
contiguous to our own. These acquisitions will enable us to provide
better service to our large retail customers, as well as to reduce
costs through economies of scale. We also plan to evaluate
international acquisition opportunities as they become available. Cash
spending on acquisitions was $176 million, $546 million and $49
million in 1999, 1998 and 1997, respectively.
CASH FLOWS
Fiscal 1999 Compared to Fiscal 1998
Operating cash flow in 1999 grew $36 million, or 29%, to $161 million from
1998. Operating cash flow is defined as net cash provided by operations less net
cash used for investments, excluding cash used for acquisitions of bottlers and
investments in affiliates.
Net cash provided by operations in 1999 improved to $718 million from $625
million in 1998, due primarily to strong growth in EBITDA and favorable working
capital cash flows resulting from the timing of cash payments and our continued
focus on working capital management.
Net cash used for investments was $733 million in 1999 compared to $1,046
million in 1998. In 1999, $176 million was utilized for the acquisition of
bottlers in the U.S., Canada and Russia, compared to $546 million in 1998. In
addition, we continued to invest heavily in cold drink equipment in North
America, resulting in increased capital spending from $507 million in 1998 to
$560 million in 1999.
34
11
Net cash provided by financing decreased by $196 million from $370 million
to $174 million during 1999, mainly due to the net pay-down of $58 million of
short-term borrowings in 1999, the payment in the first quarter of 1999 of
borrowings in Russia related to the purchase of Pepsi International Bottlers,
LLC and $90 million of share repurchases in the fourth quarter of 1999. Net IPO
proceeds of $2.2 billion and proceeds from the issuance of third-party debt of
$3.3 billion were used to repay obligations to PepsiCo and fund acquisitions.
Fiscal 1998 Compared to Fiscal 1997
Net cash provided by operations in 1998 improved to $625 million from $548
million in 1997 due primarily to the favorable effect of a three-year insurance
prepayment to a PepsiCo affiliate in 1997, and our continued focus on working
capital management.
Net cash used for investments was $1,046 million in 1998 compared to $564
million in 1997. In 1998, $546 million was utilized for the acquisition of
bottlers and investments in affiliates in the U.S., Canada and Russia, compared
to $49 million in 1997. In addition, we continued to increase our investment in
cold drink equipment in North America.
The net cash used for financing in 1998 was provided by normal operating
activities, advances from PepsiCo and proceeds from short-term borrowings. The
total net cash from financing activities in 1998 was $370 million.
MARKET RISKS AND CAUTIONARY STATEMENTS
- --------------------------------------
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks including commodity prices, interest
rates on our debt and foreign exchange rates.
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 raw materials used in our
manufacturing operations. Currently we have various contracts outstanding for
aluminum purchases in 2000, which establish our purchase price within defined
ranges.
Interest Rate Risk
Historically, we have had no material interest rate risk associated with
debt used to finance our operations due to limited third-party borrowings. We
intend to manage our interest rate exposure using both financial derivative
instruments and a mix of fixed and floating interest rate debt. During the
second quarter of 1999, we executed an interest rate swap converting 3% of our
fixed-rate debt to floating-rate debt.
Foreign Currency Exchange Rate Risk
Operating in international markets involves exposure to movements in
currency exchange rates. Currency exchange rate movements typically also affect
economic growth, inflation, interest rates, government actions and other
factors. These changes can cause us to adjust our financing and operating
strategies. The discussion below of changes in currency exchange rates does not
incorporate these other economic factors. For example, the sensitivity analysis
presented in the foreign exchange discussion below does not take into account
the possibility that the impact of an exchange rate movement may or may not be
offset by the impact of changes in other categories.
Operations outside the U.S. constitute approximately 15% of our net
revenues. As currency exchange rates change, translation of the statements of
operations of our international businesses into U.S. dollars affects
year-over-year comparability. We have not hedged translation risks because cash
flows from international operations have generally been reinvested locally, nor
historically have we entered into hedges to minimize the volatility of reported
earnings. We estimate that a 10% change in foreign exchange rates would affect
reported operating income by less than $10 million.
Foreign exchange gains and losses reflect transaction and translation gains
and losses arising from the re-measurement into U.S. dollars of the net monetary
assets of businesses in highly inflationary countries. Russia is considered a
highly inflationary economy for accounting purposes and all foreign exchange
gains and losses are included in the Consolidated Statements of Operations.
35
12
The table below presents information on contracts outstanding at December
25, 1999:
NOTIONAL CARRYING FAIR
AMOUNT AMOUNT VALUE
-------- -------- -----
dollars in millions
Raw material futures contracts............ $91 $-- $6
Raw material options...................... 61 1 12
Interest rate swap........................ 100 -- (2)
EURO
On January 1, 1999, eleven member countries of the European Union
established fixed conversion rates between existing currencies and one common
currency, the Euro. Beginning in January 2002, new Euro-denominated bills and
coins will be issued, and existing currencies will be withdrawn from
circulation. Spain is one of the member countries that instituted the Euro, and
we have established plans to address the issues raised by the Euro currency
conversion. These issues include, among others, the need to adapt computer and
financial systems, business processes and equipment such as vending machines to
accommodate Euro-denominated transactions and the impact of one common currency
on cross-border pricing. Since financial systems and processes currently
accommodate multiple currencies, we do not expect the system and equipment
conversion costs to be material. Due to numerous uncertainties, we cannot
reasonably estimate the long-term effects one common currency may have on
pricing, costs and the resulting impact, if any, on our financial condition or
results of operations.
YEAR 2000
Over the past three years, we have taken a number of steps to minimize any
potential disruption from the transition of computerized systems and
microprocessors to the Year 2000. Such steps included the inventory and
assessment of our key information technology systems, together with any
necessary remediation and testing. In addition, we contacted and surveyed
suppliers critical to our production process and significant customers as to
their compliance status. Finally, we established an Event Management Center to
monitor the status of key business processes during and after the year-end
crossover. The Center was available to all of our locations and key suppliers
and customers in the event of any breakdown in processing.
We are pleased to report that as a result of these precautions, we
experienced no disruption to our business in any of the countries in which we
operate. This included no external infrastructure issues such as disruption to
utilities and telecommunications, nor any indication of problems with any of our
key suppliers or customers. Our own production and selling activities commenced
in the new year as originally scheduled.
We have spent $51 million in costs directly related to Year 2000 issues.
This included $18 million in 1999, $26 million in 1998 and $7 million in 1997.
These costs did not necessarily increase our normal level of spending on
information technology due to the deferral of other projects that enabled us to
focus on Year 2000 remediation. Consequently, in fiscal year 2000, resources
dedicated to Year 2000 projects are now being redirected to support initiatives
that had previously been postponed. Any carryover costs to fiscal year 2000 for
expenses such as the Event Management Center are not expected to be significant.
CAUTIONARY STATEMENTS
Except for the historical information and discussions contained herein,
statements contained in this annual report on Form 10-K 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 PBG's 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 lower-than-expected
net pricing resulting from marketplace competition, material changes from
expectations in the cost of raw materials and ingredients, an inability to
achieve the expected timing for returns on cold drink equipment and related
infrastructure expenditures, material changes in expected levels of marketing
support payments from PepsiCo, an inability to meet projections for performance
in newly acquired territories, unexpected costs associated with conversion to
the common European currency and unfavorable interest rate and currency
fluctuations.
36
13
THE PEPSI BOTTLING GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in millions)
Fiscal years ended December 25, 1999 December 26 ,1998 and December 27, 1997
ACCUMULATED
ADDITIONAL OTHER
COMMON TREASURY PAID-IN RETAINED COMPREHENSIVE COMPREHENSIVE
STOCK STOCK CAPITAL EARNINGS LOSS TOTAL INCOME/(LOSS
------- -------- ---------- -------- ------------- -------- --------------
BALANCE AT DECEMBER 28, 1996 . $ -- $ -- $ -- $ -- $(102) $ (102)
Comprehensive income:
Net income ............... -- -- -- -- -- -- $ 59
Currency translation
adjustment ............. -- -- -- -- (82) (82) (82)
------- ------- ------- ----- ----- ------- -----
Total comprehensive loss ... $ (23)
=====
BALANCE AT DECEMBER 27, 1997 . -- -- -- -- (184) (184)
Comprehensive loss:
Net loss ................. -- -- -- -- -- -- $(146)
Currency translation
adjustment.............. -- -- -- -- (35) (35) (35)
Minimum pension liability
adjustment ............. -- -- -- -- (19) (19) (19)
------- ------- ------- ----- ----- ------- -----
Total comprehensive loss ... $(200)
=====
BALANCE AT DECEMBER 26, 1998 . -- -- -- -- (238) (238)
Comprehensive income:
Net loss before IPO ...... -- -- -- -- -- -- $ (29)
Net income after IPO ..... -- -- -- 147 -- 147 147
Currency translation
adjustment.............. -- -- -- -- (4) (4) (4)
Minimum pension liability
adjustment ............. -- -- -- -- 19 19 19
-----
Total comprehensive income . $ 133
=====
Initial public offering (100
shares) net of settlement
of advances from PepsiCo . 2 -- 1,736 -- -- 1,738
Treasury stock transactions,
net (5 shares) ........... -- (90) -- -- -- (90)
Cash dividends declared on
common stock ............. -- -- -- (9) -- (9)
------- ------- ------- ----- ----- -------
BALANCE AT DECEMBER 25, 1999 . $ 2 $ (90) $ 1,736 $ 138 $(223) $ 1,563
======= ======= ======= ===== ===== =======
See accompanying notes to Consolidated Financial Statements.
37
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular dollars in millions, except per share data)
NOTE 1 -- BASIS OF PRESENTATION
The Pepsi Bottling Group, Inc. ("PBG") consists of bottling operations
located in the United States, Canada, Spain, Greece and Russia. These bottling
operations manufacture, sell and distribute Pepsi-Cola beverages including
Pepsi-Cola, Diet Pepsi, Mountain Dew and other brands of carbonated soft drinks
and other ready-to-drink beverages. Approximately 90% of PBG's 1999 net revenues
were derived from the sale of Pepsi-Cola beverages. References to PBG throughout
these Consolidated Financial Statements are made using the first-person
notations of "we," "our" and "us."
Prior to our formation, we were an operating unit of PepsiCo, Inc.
("PepsiCo"). On March 31, 1999, we offered 100,000,000 shares of PBG common
stock for sale at $23 per share in an initial public offering generating $2,208
million in net proceeds. These proceeds were used to fund acquisitions and repay
obligations to PepsiCo. Subsequent to the offering, PepsiCo owned and continues
to own 55,005,679 shares of common stock, consisting of 54,917,329 shares of
common stock and 88,350 shares of Class B common stock. PepsiCo's ownership at
December 25, 1999, represents 36.7% of the outstanding common stock and 100% of
the outstanding Class B common stock, together representing 44.8% of the voting
power of all classes of our voting stock. Subsequent to the offering, PepsiCo
also owns 7.1% of the equity of Bottling Group, LLC, our principal operating
subsidiary, giving PepsiCo economic ownership of 41.2% of our combined
operations at December 25, 1999.
The 154,917,354 common shares and 88,350 Class B common shares 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 held by
PepsiCo is, at PepsiCo's option, 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.
The accompanying Consolidated Financial Statements include information that
has been presented on a "carve-out" basis for the periods prior to our initial
public offering. This information includes the historical results of operations
and assets and liabilities directly related to PBG, and has been prepared from
PepsiCo's historical accounting records. Certain estimates, assumptions and
allocations were made in determining such financial statement information.
Therefore, these Consolidated Financial Statements may not necessarily be
indicative of the results of operations, financial position or cash flows that
would have existed had we been a separate, independent company from the first
day of all periods presented.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Our preparation of the Consolidated Financial Statements in conformity with
generally accepted accounting principles requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of net revenues and expenses during the
reporting period. Actual results could differ from our estimates.
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 fiscal year ends on the last Saturday in December and, as a
result, a fifty-third week is added every five or six years. Fiscal years 1999,
1998 and 1997 consisted of 52 weeks. Fiscal year 2000 will have 53 weeks.
REVENUE RECOGNITION We recognize revenue when goods are delivered to
customers. Sales terms do not allow a right of return unless product freshness
dating has expired. Reserves for returned product were $2 million at fiscal
year-end 1999, 1998 and 1997, respectively.
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 and expense such costs in the year
incurred. Advertising and marketing costs were $298 million, $233 million and
$210 million in 1999, 1998 and 1997, respectively.
BOTTLER INCENTIVES PepsiCo and other brand owners, at their sole discretion,
provide us with various forms of marketing support. This marketing support is
intended to cover a variety of programs and initiatives, including direct
marketplace support, capital equipment funding and shared media and advertising
support. Based on the objective of the programs and initiatives, we record
marketing support
38
15
as an adjustment to net revenues or as a reduction of selling, delivery and
administrative expenses. Direct marketplace support is primarily funding by
PepsiCo and other brand owners of sales discounts and similar programs and is
recorded as an adjustment to net revenues. Capital equipment funding is designed
to support the purchase and placement of marketing equipment and is recorded as
a reduction to selling, delivery and administrative expenses. Shared media and
advertising support is recorded as a reduction to advertising and marketing
expense within selling, delivery and administrative expenses. There are no
conditions or other requirements that could result in a repayment of marketing
support received.
The total bottler incentives we received from PepsiCo and other brand
owners, were $563 million, $536 million and $463 million for 1999, 1998 and
1997, respectively. Of these amounts, we recorded $263 million, $247 million and
$235 million for 1999, 1998 and 1997, respectively, in net revenues, and the
remainder as a reduction to selling, delivery and administrative expenses. The
amount of our bottler incentives received from PepsiCo was more than 90% of our
bottler incentives in each of the three years, with the balance received from
the other brand owners.
STOCK-BASED EMPLOYEE COMPENSATION We measure stock-based compensation
expense in accordance with Accounting Principles Board Opinion 25, "Accounting
for Stock Issued to Employees," and its related interpretations. Accordingly,
compensation expense for stock option grants to PBG 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.
CASH EQUIVALENTS Cash equivalents represent funds we have temporarily
invested with original maturities not exceeding three months.
INVENTORIES We value our inventories at the lower of cost computed on the
first-in, first-out method or net realizable value.
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.
INTANGIBLE ASSETS Intangible assets include both franchise rights and
goodwill arising from the allocation of the purchase price of businesses
acquired. Goodwill represents the residual purchase price after allocation of
all identifiable net assets. Franchise rights and goodwill are evaluated at the
date of acquisition and amortized on a straight-line basis over their estimated
useful lives, which in most cases is between 20 to 40 years.
RECOVERABILITY OF LONG-LIVED ASSETS We review all long-lived assets,
including intangible assets, when facts and circumstances indicate that the
carrying value of the asset may not be recoverable. When necessary, we write
down an impaired asset to its estimated fair value based on the best information
available. Estimated fair value is generally based on either appraised value or
measured by discounting estimated future cash flows. Considerable management
judgment is necessary to estimate discounted future cash flows. Accordingly,
actual results could vary significantly from such estimates.
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.
As a result of the contribution of these assets, PBG owns 92.9% of Bottling
Group, LLC and PepsiCo owns the remaining 7.1%. Accordingly, the Consolidated
Financial Statements reflect PepsiCo's share of 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 from our initial
public offering through the end of the year.
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 shares but not included in our
shares outstanding. We record shares reissued using an average cost. During
1999, our Board of Directors authorized the repurchase of 10 million shares of
common stock under which we made net repurchases of 5.3 million shares for $90
million.
39
16
FINANCIAL INSTRUMENTS AND RISK MANAGEMENT We use futures contracts and
options on futures to hedge against the risk of adverse movements in the price
of certain commodities used in the manufacture of our products. In order to
qualify for deferral hedge accounting of unrealized gains and losses, such
instruments must be designated and effective as a hedge of an anticipatory
transaction. Changes in the value of instruments that we use to hedge commodity
prices are highly correlated to the changes in the value of the purchased
commodity.
We review the correlation and effectiveness of these financial instruments
on a periodic basis. Gains and losses on futures contracts that are designated
and effective as hedges of future commodity purchases are deferred and included
in the cost of the related raw materials when purchased. Financial instruments
that do not meet the criteria for hedge accounting treatment are
marked-to-market with the resulting unrealized gain or loss recorded as other
income and expense within selling, delivery and administrative expenses.
Realized gains and losses that result from the early termination of financial
instruments used for hedging purposes are deferred and are included in cost of
sales when the anticipated transaction actually occurs. Premiums paid for the
purchase of options on futures are recorded as a prepaid expense in the
Consolidated Balance Sheets and are amortized as an adjustment to cost of sales
over the duration of the contract.
From time to time, we utilize interest rate swaps to hedge our exposure to
fluctuations in interest rates. The interest differential to be paid or received
on an interest rate swap is recognized as an adjustment to interest expense as
the differential occurs. The interest differential not yet settled in cash is
reflected in the accompanying Consolidated Balance Sheets as a receivable or
payable within the appropriate current asset or liability captions. If we
terminate an interest rate swap position, the gain or loss realized upon
termination would be deferred and amortized to interest expense over the
remaining term of the underlying debt instrument it was intended to modify, or
would be recognized immediately if the underlying debt instrument was settled
prior to maturity.
FOREIGN EXCHANGE 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 exchange gains and
losses reflect transaction and translation gains and losses arising from the
re-measurement into U.S. dollars of the net monetary assets of businesses in
highly inflationary countries. Russia is considered a highly inflationary
economy for accounting purposes and we include all foreign exchange gains and
losses in the Consolidated Statements of Operations.
NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standard 133, "Accounting
for Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for hedging activities and derivative
instruments, including certain derivative instruments embedded in other
contracts, which are collectively referred to as derivatives. It requires that
an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. We
are currently assessing the effects of adopting SFAS 133, and have not yet made
a determination of the impact on our financial position or results of
operations.
In July 1999, the FASB issued Statement of Financial Accounting Standard
137, delaying the implementation of SFAS 133 for one year. SFAS 133 will now be
effective for our first quarter of fiscal year 2001.
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 or
converted into common stock that would then share in net income.
NOTE 3 -- INITIAL PUBLIC OFFERING AND COMPARABILITY OF RESULTS
For the periods prior to our initial public offering, our Consolidated
Financial Statements have been carved out from the financial statements of
PepsiCo using the historical results of operations and assets and liabilities of
our
40
17
business. The Consolidated Financial Statements reflect certain costs that may
not necessarily be indicative of the costs we would have incurred had we
operated as an independent, stand-alone entity for all periods presented. These
costs include an allocation of PepsiCo corporate overhead and interest expense,
and income taxes.
- We included corporate overhead related to PepsiCo's corporate
administrative functions based on a specific identification of
PepsiCo's administrative costs relating to the bottling operations
and, to the extent that such identification was not practicable, based
upon the percentage of our revenues to PepsiCo's consolidated net
revenues. These costs are included in selling, delivery and
administrative expenses in our Consolidated Statements of Operations.
- We allocated $3.3 billion of PepsiCo debt to our business. We charged
interest expense on this debt using PepsiCo's weighted-average
interest rate. Once we issued $3.3 billion of third-party debt in the
first quarter of 1999, our actual interest rates were used to
determine interest expense for the remainder of the year.
- We reflected income tax expense in our Consolidated Financial
Statements as if we had actually filed a separate income tax return.
The amounts, by year, of the historical allocations described above are as
follows:
1999* 1998 1997
----- ---- ----
Corporate overhead expense............................... $ 3 $ 40 $ 42
Interest expense......................................... $ 28 $210 $205
PepsiCo weighted-average interest rate................... 5.8% 6.4% 6.2%
*Prior to our initial public offering.
In addition, our historical capital structure is not representative of our
current structure due to our initial public offering. In 1999, immediately
preceding the offering and in 1998 and 1997, we had 55,000,000 shares of common
stock outstanding. In connection with the offering, we sold 100,000,000 shares
to the public.
NOTE 4 -- UNUSUAL IMPAIRMENT AND OTHER CHARGES AND CREDITS
1999 1998*
---- -----
Non-cash compensation charge............................ $ 45 $ --
Vacation policy change.................................. (53) --
Asset impairment and restructuring charges.............. (8) 222
---- ----
$(16) $222
==== ====
After minority interest and income taxes.................. $ (9) $218
==== ====
*Does not include tax settlement with the Internal Revenue Service
discussed on the next page.
The 1999 unusual items comprise the following:
- In connection with the completion of our initial public offering,
PepsiCo vested substantially all non-vested PepsiCo stock options held
by PBG employees. As a result, we incurred a $45 million non-cash
compensation charge in the second quarter, equal to the difference
between the market price of the PepsiCo capital stock and the exercise
price of these options at the vesting date.
- Employees will now earn vacation time evenly throughout the year based
upon service rendered. Previously, employees were fully vested for the
current year at the beginning of each year. As a result of this
change, we have reversed an accrual of $53 million into income.
- In the fourth quarter, $8 million of the remaining 1998 restructuring
reserve was reversed into income, as actual costs incurred to
renegotiate manufacturing and leasing contracts in Russia and to
reduce the number of employees were less than the amounts originally
estimated.
The 1998 unusual items comprise the following:
- A fourth-quarter charge of $212 million for asset impairment of $194
million and other charges of $18 million related to the restructuring
of our Russian bottling operations. The economic turmoil in Russia,
which accompanied the devaluation of the ruble in August 1998, had an
41
18
adverse impact on our operations. Consequently, in the fourth quarter
we experienced a significant drop in demand, resulting in lower net
revenues and increased operating losses. Additionally, since net
revenues in Russia are denominated in rubles, whereas a substantial
portion of costs and expenses at that time were denominated in U.S.
dollars, our operating margins were further eroded. In response to
these conditions, we reduced our cost structure primarily through
closing four of our 26 distribution facilities, renegotiating
manufacturing and leasing contracts and reducing the number of
employees, primarily in sales and operations, from approximately 4,500
to 2,000. We also evaluated the resulting impairment of long-lived
assets, triggered by the reduction in utilization of assets caused by
the lower demand, the adverse change in the business climate and the
expected continuation of operating losses and cash deficits in that
market. The impairment charge reduced the net book value of these
assets from $245 million to $51 million, their estimated fair market
value based primarily on values paid for similar assets in Russia.
A fourth-quarter charge of $10 million for employee-related and other
costs, mainly relocation and severance, resulting from the separation
of Pepsi-Cola North America's concentrate and bottling organizations.
At year-end 1999, $3 million remained in accounts payable and other
current liabilities relating to remaining lease termination costs on
facilities and employee costs to be paid in 2000.
- We recognized an income tax benefit of $46 million in the fourth
quarter of 1998 upon the settlement of a disputed claim with the
Internal Revenue Service relating to the deductibility of the
amortization of acquired franchise rights. The settlement also
resulted in the reduction of goodwill and income taxes payable by $194
million.
NOTE 5 -- INVENTORIES
1999 1998
---- ----
Raw materials and supplies........... $ 110 $ 120
Finished goods....................... 183 176
----- -----
$ 293 $ 296
===== =====
NOTE 6 -- PROPERTY, PLANT AND EQUIPMENT, NET
1999 1998
------- -------
Land .............................. $ 145 $ 151
Buildings and improvements ........ 852 813
Production and distribution
equipment ......................... 2,112 1,989
Marketing equipment ............... 1,596 1,368
Other ............................. 84 95
------- -------
4,789 4,416
Accumulated depreciation .......... (2,571) (2,361)
------- -------
$ 2,218 $ 2,055
======= =======
We calculate depreciation on a straight-line basis over the estimated lives
of the assets as follows:
Building and improvements............................. 20-33 years
Production equipment.................................. 10 years
Distribution equipment................................ 5-8 years
Marketing equipment................................... 3-7 years
NOTE 7 -- INTANGIBLE ASSETS, NET
1999 1998
------- -------
Franchise rights and other identifiable intangibles $ 3,565 $ 3,460
Goodwill ........................................... 1,582 1,539
------- -------
5,147 4,999
Accumulated amortization ........................... (1,328) (1,193)
------- -------
$ 3,819 $ 3,806
======= =======
Identifiable intangible assets arise principally from the allocation of the
purchase price of businesses acquired, and consist primarily of territorial
franchise rights. Our franchise rights are typically perpetual in duration,
subject to compliance with the underlying franchise agreement. We assign amounts
to such identifiable intangibles based on their estimated fair value at the date
of acquisition. Goodwill represents the residual purchase price after allocation
to all identifiable net assets.
NOTE 8 -- ACCOUNTS PAYABLE AND OTHER CURRENT LIABILITIES
1999 1998
---- ----
Accounts payable ............................... $334 $328
Accrued compensation and benefits .............. 147 174
Trade incentives ............................... 201 163
Accrued interest ............................... 69 --
Other current liabilities ...................... 173 239
---- ----
$924 $904
==== ====
42
19
NOTE 9 -- SHORT-TERM BORROWINGS AND LONG-TERM DEBT
1999 1998
------ ------
Short-term borrowings
Current maturities of long-term debt .............. $ 10 $ 48
Borrowings under lines of credit .................. 13 64
------ ------
$ 23 $ 112
====== ======
Long-term debt due to third parties
5 5/8% senior notes due 2009 ...................... $1,300 $ --
5 3/8% senior notes due 2004 ...................... 1,000 --
7% senior notes due 2029 .......................... 1,000 --
Other ............................................. 13 102
------ ------
3,313 102
Capital lease obligations ......................... 2 7
------ ------
3,315 109
Less: Unamortized discount ........................ 37 --
Current maturities of long-term debt ........ 10 48
------ ------
$3,268 $ 61
====== ======
Allocation of PepsiCo long-term debt ................. $ -- $3,300
====== ======
Maturities of long-term debt as of December 25, 1999 are: 2000 -- $9
million, 2001 -- $1 million, 2002 -- $0, 2003 -- $0, 2004 -- $1,000 million and
thereafter, $2,303 million.
The $1.3 billion of 5 5/8% senior notes and the $1.0 billion of 5 3/8%
senior notes were issued on February 9, 1999, by our subsidiary Bottling Group,
LLC and are guaranteed by PepsiCo. We issued the $1.0 billion of 7% senior
notes, which are guaranteed by Bottling Group, LLC, on March 8, 1999. During the
second quarter we executed an interest rate swap converting 3% of our fixed-rate
debt to floating-rate debt.
We allocated $3.3 billion of PepsiCo long-term debt in our financial
statements prior to issuing the senior notes referred to above. Our interest
expense includes the related allocated interest expense of $28 million in 1999,
$210 million in 1998 and $205 million in 1997, and is based on PepsiCo's
weighted-average interest rate of 5.8%, 6.4% and 6.2% in 1999, 1998 and 1997,
respectively.
In April 1999, we entered into a $500 million commercial paper program that
is supported by a credit facility. The credit facility consists of two $250
million components, one of which is one year in duration and the other of which
is five years in duration. There were no borrowings outstanding under this
program at December 25, 1999.
We have available short-term bank credit lines of approximately $121
million and $95 million at December 25, 1999 and December 26, 1998,
respectively. These lines are denominated in various foreign currencies to
support general operating needs in their respective countries. The
weighted-average interest rate of these lines of credit outstanding at December
25, 1999, December 26, 1998 and December 27, 1997 was 12.0%, 8.7% and 8.6%,
respectively.
Amounts paid to third parties for interest were $108 million, $20 million
and $21 million in 1999, 1998 and 1997, respectively. In 1998 and 1997,
allocated interest expense was deemed to have been paid to PepsiCo, in cash, in
the period in which the cost was incurred.
NOTE 10 -- LEASES
We have noncancellable commitments under both capital and long-term
operating leases. Capital and operating lease commitments expire at various
dates through 2023. Most leases require payment of related executory costs,
which include property taxes, maintenance and insurance.
Our future minimum commitments under noncancellable leases are set forth
below:
COMMITMENTS
--------------------
CAPITAL OPERATING
------- ---------
2000................................................. $ 1 $ 33
2001................................................. -- 29
2002................................................. -- 25
2003................................................. -- 14
2004................................................. -- 12
Later years.......................................... 3 58
---- ----
$ 4 $171
==== ====
At December 25, 1999, the present value of minimum payments under capital
leases was $2 million, after deducting $2 million for imputed interest. Our
rental expense was $55 million, $45 million and $35 million for 1999, 1998 and
1997, respectively.
43
20
NOTE 11 -- FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
As of December 25, 1999, our use of derivative instruments was limited to
interest rate swaps entered into with financial institutions, and commodity
futures and options contracts traded on national exchanges. Our corporate policy
prohibits the use of derivative instruments for trading purposes, and we have
procedures in place to monitor and control their use.
FAIR VALUE Financial assets with carrying values approximating fair value
include cash and cash equivalents and trade 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 the short
maturity of our financial assets and liabilities, and since interest rates
approximate fair value for short-term debt.
Long-term debt at December 25, 1999 has a carrying value and fair value of
$3.3 billion and $3.0 billion, respectively.
COMMODITY PRICES We use futures contracts and options on futures in the
normal course of business to hedge anticipated purchases of certain raw
materials used in our manufacturing operations.
Deferred gains and losses at year-end 1999 and 1998, as well as gains and
losses recognized as part of the cost of sales in 1999, 1998 and 1997, were not
significant. At year-end 1999 and 1998, we had commodity contracts involving
notional amounts of $152 million and $71 million outstanding, respectively.
These notional amounts do not represent amounts exchanged by the parties and
thus are not a measure of our exposure; rather, they are used as the basis to
calculate the amounts due under the agreements.
INTEREST RATE RISK Prior to the initial public offering, we had minimal
external interest rate risk to manage. Subsequent to the offering, as interest
rate risk has grown, we have begun to manage interest rate exposure through the
use of an interest rate swap, which converted 3% of our fixed-rate debt to
floating-rate debt. Credit risk from the swap agreement is dependent both on the
movement in interest rates and the possibility of non-payment by the swap
counterparty. We mitigate credit risk by only entering into swap agreements with
high credit-quality counterparties and by netting swap payments within each
contract.
AT DECEMBER 25, 1999
--------------------------------
NOTIONAL CARRYING FAIR
AMOUNT AMOUNT VALUE
-------- -------- -----
Raw material futures contracts ......... $ 91 $ -- $ 6
Raw material options ................... 61 1 12
Interest rate swap ..................... 100 -- (2)
NOTE 12 -- PENSION AND POSTRETIREMENT BENEFIT PLANS
PENSION BENEFITS
Prior to the initial public offering, our U.S. employees participated in
PepsiCo sponsored noncontributory defined benefit pension plans, which covered
substantially all full-time salaried employees, as well as most hourly
employees. In conjunction with the offering, we assumed the sponsorship of the
PepsiCo plan covering most hourly employees and established a plan for the
salaried employees mirroring the PepsiCo-sponsored plan. In 2000, the related
pension assets will be transferred from the PepsiCo trust to a separate trust
for our pension plans.
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 nor more than the maximum amount that can be deducted for U.S.
income tax purposes. Our net pension expense for the defined benefit pension
plans for our operations outside the U.S. was not significant.
POSTRETIREMENT BENEFITS
PepsiCo has historically provided postretirement health care benefits to
eligible retired employees and their dependents, principally in the United
States. 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. With our initial public offering,
we have assumed the related obligations from PepsiCo for our employees, as we
are providing benefits similar to those previously provided by PepsiCo.
44
21
PENSION
--------------------------
Components of net periodic benefit costs 1999 1998 1997
---- ---- ----
Service cost .................................. $ 30 $ 24 $ 22
Interest cost ................................. 42 37 35
Expected return on plan assets ................ (49) (45) (41)
Amortization of transition asset .............. -- (2) (4)
Amortization of net loss ...................... 4 -- --
Amortization of prior service amendments ...... 5 4 4
---- ---- ----
Net periodic benefit cost ..................... 32 18 16
Settlement loss ............................... -- 1 --
---- ---- ----
Net periodic benefit cost including settlements $ 32 $ 19 $ 16
==== ==== ====
POSTRETIREMENT
--------------------------
Components of net periodic benefit costs: 1999 1998 1997
---- ---- ----
Service cost .................................. $ 4 $ 4 $ 3
Interest cost ................................. 12 12 15
Expected return on plan assets ................ -- -- --
Amortization of transition asset .............. -- -- --
Amortization of net loss ...................... -- -- --
Amortization of prior service amendments ...... (5) (5) (5)
---- ---- ----
Net periodic benefit cost ..................... 11 11 13
Settlement loss ............................... -- -- --
---- ---- ----
Net periodic benefit cost including settlements $ 11 $ 11 $ 13
==== ==== ====
We amortize prior service costs on a straight-line basis over the average
remaining service period of employees expected to receive benefits.
PENSION POSTRETIREMENT
----------------- -----------------
Changes in the benefit obligation: 1999 1998 1999 1998
----- ----- ----- -----
Obligation at beginning of year $ 648 $ 545 $ 187 $ 164
Service cost ................... 30 24 4 4
Interest cost .................. 42 37 12 12
Plan amendments ................ 3 5 -- --
Actuarial (gain)/loss .......... (57) 78 14 19
Benefit payments ............... (38) (36) (11) (12)
Acquisitions and other ......... 19 -- -- --
Settlement gain ................ -- (5) -- --
----- ----- ----- -----
Obligation at end of year ...... $ 647 $ 648 $ 206 $ 187
===== ===== ===== =====
PENSION POSTRETIREMENT
---------------- ---------------
Changes in the fair value of assets: 1999 1998 1999 1998
----- ----- ---- ----
Fair value at beginning of year ... $ 541 $ 602 $ -- $ --
Actual return on plan assets ...... 85 (26) -- --
Employer contributions ............ -- 5 11 12
Benefit payments .................. (38) (36) (11) (12)
Acquisitions and other ............ 9 -- -- --
Settlement gain ................... -- (4) -- --
----- ----- ---- ----
Fair value at end of year ......... $ 597 $ 541 $ -- $ --
===== ===== ==== ====
Selected information for the plans with accumulated benefit obligations in
excess of plan assets:
PENSION POSTRETIREMENT
----------------- -----------------
1999 1998 1999 1998
----- ---- ---- -----
Projected benefit obligation ............ $ (32) $(648) $(206) $(187)
Accumulated benefit obligation .......... (12) (575) (206) (187)
Fair value of plan assets ............... -- 541 -- --
Funded status recognized on the Consolidated Balance Sheets:
PENSION POSTRETIREMENT
----------------- -----------------
1999 1998 1999 1998
----- ----- ----- -----
Funded status at end of year ............ $ (50) $(107) $(206) $(187)
Unrecognized prior service cost ......... 33 34 (17) (22)
Unrecognized (gain)/loss ................ (14) 84 35 20
Unrecognized transition asset ........... -- (1) -- --
Unrecognized special termination benefits (2) (2) -- --
Employer contributions .................. -- -- 3 --
----- ----- ----- -----
Net amounts recognized .................. $ (33) $ 8 $(185) $(189)
===== ===== ===== =====
45
22
The weighed-average assumptions used to compute the above information are
set forth below:
PENSION
----------------------------
1999 1998 1997
---- ---- ----
Discount rate for benefit obligation ....... 7.8% 6.8% 7.2%
Expected return on plan assets ............. 10.0 10.0 10.0
Rate of compensation increase .............. 4.3 4.8 4.8
POSTRETIREMENT
----------------------------
1999 1998 1997
---- ---- ----
Discount rate for benefit obligation ....... 7.8% 6.9% 7.4%
COMPONENTS OF PENSION ASSETS
The pension plan assets are principally invested in stocks and bonds.
HEALTH CARE COST TREND RATES
We have assumed an average increase of 6.0% in 2000 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
5.5% in 2005 and thereafter.
Assumed health care cost trend rates have a significant effect on the
amounts reported for postretirement medical plans. A one-percentage point change
in assumed health care costs would have the following effects:
1% 1%
INCREASE DECREASE
-------- --------
Effect on total fiscal year 1999 service and interest cost components.............. $ 1 $(1)
Effect on the fiscal year 1999 accumulated postretirement benefit obligation....... 6 (6)
OTHER EMPLOYEE BENEFIT PLANS
In the fourth quarter of 1999, we contributed $16 million to a defined
contribution plan as a one-time payment for the benefit of management employees.
The amount was based on full-year 1999 performance and included other
incentive-related features.
Our Board of Directors has also approved a matching company contribution to
our 401(k) plan to begin in 2000. The match will be made in PBG stock and the
amount will depend upon the employee's contribution and years of service. We
anticipate that the matching company contribution will cost approximately $12
million in fiscal year 2000.
NOTE 13 -- EMPLOYEE STOCK OPTION PLANS
In connection with the completion of our initial public offering, PepsiCo
vested substantially all non-vested PepsiCo stock options held by PBG employees.
As a result, we incurred a $45 million non-cash compensation charge in the
second quarter, equal to the difference between the market price of the PepsiCo
capital stock and the exercise price of these options at the vesting date.
Also at the time of our initial public offering, we issued a one-time
founders' grant of options to all full-time non-management employees to purchase
100 shares of PBG stock. These options have an exercise price equal to the
initial public offering price of $23 per share, are exercisable after three
years, and expire in 10 years. At December 25, 1999, approximately 3 million
options were outstanding.
In addition, we have adopted a long-term incentive stock option plan for
middle and senior management employees. We issued an option grant to middle and
senior management employees that varied according to salary and level within
PBG. These options' exercise prices range from $19.25 per share to $23 per share
and, with the exception of our chairman's options, are exercisable after three
years and expire in 10 years. Our chairman's options are exercisable ratably
over the three years following our initial public offering date. At December 25,
1999, approximately 8.2 million options were outstanding.
46
23
The following table summarizes option activity during 1999:
1999
----------------------
WEIGHTED-
AVERAGE
(OPTIONS IN MILLIONS) EXERCISE
OPTIONS PRICE
------- ---------
Outstanding at beginning of year ............................. -- $ --
Granted ................................................... 12.1 22.98
Exercised ................................................. -- --
Forfeited ................................................. (0.9) 23.33
------ ------
Outstanding at end of year ................................... 11.2 $22.98
====== ======
Exercisable at end of year ................................... -- $ --
====== ======
Weighted-average fair value of options granted during the year $10.29
======
We adopted the disclosure provisions of Statement of Financial Accounting
Standard 123, "Accounting for Stock-Based Compensation," but continue to measure
stock-based compensation cost in accordance with the Accounting Principles Board
Opinion 25 and its related interpretations. If we had measured compensation cost
for the stock options granted to our employees in 1999 under the fair value
based method prescribed by SFAS 123, net income would have been changed to the
pro forma amounts set forth below:
1999
----
Net Income
Reported.......................................................... $ 118
Pro forma......................................................... 102
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
option-pricing model based on the following weighted-average assumptions:
1999
-------
Risk-free interest rate.............................................. 5.8%
Expected life........................................................ 7 years
Expected volatility.................................................. 30%
Expected dividend yield.............................................. 0.09%
NOTE 14 -- INCOME TAXES
The details of our income tax provision are set forth below:
1999 1998 1997
---- ---- ----
Current: Federal ............... $ 79 $(84) $ 31
Foreign ............... (1) 4 3
State ................. 19 (13) 5
---- ---- ----
97 (93) 39
---- ---- ----
Deferred: Federal ............. (17) 45 17
Foreign ............. -- (5) (2)
State ............... (10) 7 2
---- ---- ----
(27) 47 17
---- ---- ----
$ 70 $(46) $ 56
==== ==== ====
Our U.S. and foreign income (loss) before income taxes is set forth below:
1999 1998 1997
---- ---- ----
U.S. ..................... $ 188 $ 116 $ 177
Foreign .................. -- (308) (62)
---- ---- ----
$ 188 $(192) $ 115
==== ==== ====
Our reconciliation of income taxes calculated at the U.S. federal statutory
rate to our provision for income taxes is set forth below:
1999 1998 1997
---- ----- ----
Income taxes computed at the U.S. federal statutory rate 35.0% (35.0)% 35.0%
State income tax, net of federal tax benefit ........... 3.2 -- 4.4
Impact of foreign results .............................. (9.1) (12.2) (9.5)
U.S. goodwill and other nondeductible expenses ......... 7.8 7.5 14.8
U.S. franchise rights tax settlement ................... -- (24.0) --
Unusual impairment and other charges and credits ....... (0.6) 38.7 --
Other, net ............................................. 1.1 1.0 4.0
---- ----- ----
Total effective income tax rate ........................ 37.4% (24.0)% 48.7%
==== ===== ====
47
24
The details of our 1999 and 1998 deferred tax liabilities (assets) are set
forth below:
1999 1998
------- -------
Intangible assets and property, plant and equipment ............ $ 1,231 $ 1,252
Other .......................................................... 90 112
------- -------
Gross deferred tax liabilities ................................. 1,321 1,364
------- -------
Foreign net operating loss carryforwards ....................... (132) (123)
Employee benefit obligations ................................... (77) (85)
Bad debts ...................................................... (21) (20)
Various liabilities and other .................................. (157) (164)
------- -------
Gross deferred tax assets ...................................... (387) (392)
Deferred tax asset valuation allowance ......................... 147 135
------- -------
Net deferred tax assets ........................................ (240) (257)
------- -------
Net deferred tax liability ..................................... $ 1,081 $ 1,107
======= =======
Included in:
Prepaid expenses, deferred income taxes and other current assets $ (97) $ (95)
Deferred income taxes .......................................... 1,178 1,202
------- -------
$ 1,081 $ 1,107
======= =======
We have net operating loss carryforwards totaling $465 million at December
25, 1999, which are available to reduce future taxes in Spain, Greece and
Russia. Of these carryforwards, $37 million expire in 2000 and $428 million
expire at various times between 2001 and 2006. We have established a full
valuation allowance for these net operating loss carryforwards based upon our
projection that these losses will expire before they can be used.
Our valuation allowances, which reduce deferred tax assets to an amount
that will more likely than not be realized, have increased by $12 million and
$55 million in 1999 and 1998, respectively.
Amounts paid to taxing authorities for income taxes were $111 million in
1999. In 1998 and 1997 our allocable share of income taxes was deemed to have
been paid to PepsiCo, in cash, in the period in which the cost was incurred.
NOTE 15 -- GEOGRAPHIC DATA
We operate in one industry, carbonated soft drinks and other ready-to-drink
beverages. We do business in 41 states and the District of Columbia in the U.S.
Outside the U.S., we do business in eight Canadian provinces, Spain, Greece and
Russia.
NET REVENUES
------------------------------------
1999 1998 1997
------ ------ ------
U.S. .............................. $6,352 $5,886 $5,584
Other countries ................... 1,153 1,155 1,008
------ ------ ------
$7,505 $7,041 $6,592
====== ====== ======
LONG-LIVED ASSETS
------------------------------------
1999 1998 1997
------ ------ ------
U.S. .............................. $5,139 $5,024 $4,918
Other countries ................... 987 980 934
------ ------ ------
$6,126 $6,004 $5,852
====== ====== ======
We have included in other assets on the Consolidated Balance Sheets $2
million, $1 million and $64 million of investments in joint ventures at December
25, 1999, December 26, 1998 and December 27, 1997, respectively. Our equity loss
in such joint ventures was $0 million, $5 million and $12 million in 1999, 1998
and 1997, respectively, which is included in selling, delivery and
administrative expenses.
NOTE 16 -- RELATIONSHIP WITH PEPSICO
At the time of the initial public offering we entered into a number of
agreements with PepsiCo. The most significant agreements that govern our
relationship with PepsiCo consist of:
(1) the master bottling agreement for cola beverages bearing the
"Pepsi-Cola" and "Pepsi" trademark, including Pepsi, Diet Pepsi and
Pepsi ONE in the United States; bottling and distribution agreements
for non-cola products in the United States, including Mountain Dew;
and a master fountain syrup agreement in the United States;
48
25
(2) agreements similar to the master bottling agreement and the non-cola
agreements for each specific country, including Canada, Spain, Greece
and Russia, as well as a fountain syrup agreement similar to the
master syrup agreement for Canada;
(3) a shared services agreement whereby PepsiCo provides us with certain
administrative support, including procurement of raw materials,
transaction processing, such as accounts payable and credit and
collection, certain tax and treasury services, and information
technology maintenance and systems development. Beginning in 1998, a
PepsiCo affiliate has provided casualty insurance to us; and
(4) transition agreements that provide certain indemnities to the parties,
and provide for the allocation of tax and other assets, liabilities
and obligations arising from periods prior to the initial public
offering. Under our tax separation agreement, PepsiCo maintains full
control and absolute discretion for any combined or consolidated tax
filings for tax periods ending on or before the initial public
offering. PepsiCo has contractually agreed to act in good faith with
respect to all tax audit matters affecting us. In addition, PepsiCo
has agreed to use their best efforts to settle all joint interests in
any common audit issue on a basis consistent with prior practice.
We purchase concentrate from PepsiCo that is used in the production of
carbonated soft drinks and other ready-to-drink beverages. We also produce or
distribute other products and purchase finished goods and concentrate through
various arrangements with PepsiCo or PepsiCo joint ventures. We reflect such
purchases in cost of sales.
We share a business objective with PepsiCo of increasing the availability
and consumption of Pepsi-Cola beverages. Accordingly, PepsiCo provides us with
various forms of marketing support to promote its beverages. This support covers
a variety of initiatives, including marketplace support, marketing programs,
capital equipment investment and shared media expense. Based on the objective of
the programs and initiatives, we record marketing support as an adjustment to
net revenues or as a reduction of selling, delivery and administrative expense.
We manufacture and distribute fountain products and provide fountain
equipment service to PepsiCo customers in some territories in accordance with
the Pepsi beverage agreements. We pay a royalty fee to PepsiCo for the AQUAFINA
trademark.
The Consolidated Statements of Operations include the following income
(expense) amounts as a result of transactions with PepsiCo and its affiliates:
1999 1998 1997
------- ------- -------
Net revenues .................................. $ 236 $ 228 $ 216
Cost of sales ................................. (1,488) (1,396) (1,235)
Selling, delivery and administrative expenses . 285 260 254
We are not required to make any minimum fees or payments to PepsiCo, nor
are we obligated to PepsiCo under any minimum purchase requirements. There are
no conditions or requirements that could result in the repayment of any
marketing support payments received by us from PepsiCo.
Net amounts receivable from PepsiCo and its affiliates were $5 million and
net amounts payable to PepsiCo and its affiliates were $23 million at December
25, 1999 and December 26, 1998, respectively. Such amounts are recorded within
accounts payable and other current liabilities in our Consolidate Balance
Sheets.
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.
49
26
NOTE 18 -- ACQUISITIONS
During 1999 and 1998, we acquired the exclusive right to manufacture, sell
and distribute Pepsi-Cola beverages from several independent PepsiCo franchise
bottlers. These acquisitions were accounted for by the purchase method. During
1999, the following acquisitions occurred for an aggregate purchase price of
$185 million in cash and assumed debt:
- - Jeff Bottling Company, Inc. of New York in January.
- - Pepsi-Cola General Bottlers of Princeton, Inc. and Pepsi-Cola General
Bottlers of Virginia, Inc. of West Virginia and Virginia in March.
- - Pepsi-Cola General Bottlers of St. Petersburg, Russia in March.
- - Leader Beverage Corporation of Connecticut in April.
- - Guillemette & Frere, Ltee. of Quebec, Canada in September.
- - The Pepsi-Cola Bottling Company of Bainbridge, Inc. of Georgia in
December.
During 1998, the following acquisitions occurred for an aggregate cash
purchase price of $546 million:
- - The remaining 75% interest in our Russian bottling joint venture, Pepsi
International Bottlers, LLC in February.
- - Gray Beverages, Inc. of Alberta and British Columbia, Canada in May.
- - Pepsi-Cola Allied Bottlers, Inc. of New York and Connecticut in
November.
The 1999 and 1998 aggregate purchase price exceeded the fair value of net
assets acquired, including the resulting tax effect, by approximately $174
million and $474 million, respectively. The excess was recorded in intangible
assets.
The following table presents the unaudited pro forma consolidated results
of PBG and the acquisitions noted above as if they had occurred at the beginning
of the year in which they were acquired. The pro forma information does not
necessarily represent what the actual results would have been for these periods
and is not intended to be indicative of future results.
Unaudited
----------------
1999 1998
------ -------
Pro forma net revenues ..................................... $7,522 $ 7,248
====== =======
Pro forma net income (loss) ................................ 117 (135)
====== =======
Pro forma earnings (loss) per share (155 million shares) ... 0.76 (0.87)
====== =======
NOTE 19 -- COMPUTATION OF BASIC AND DILUTED EARNINGS (LOSS) PER SHARE
(shares in thousands)
1999 1998 1997
-------- -------- --------
Number of shares on which basic earnings (loss)
per share is based:
Average outstanding during period ............... 128,426 55,000 55,000
Add - Incremental shares under stock
compensation plans ............................ -- -- --
-------- -------- --------
Number of shares on which diluted
earnings (loss) per share is based .............. 128,426 55,000 55,000
Basic and diluted net earnings (loss) applicable to
common shareholders ............................ $ 118 $ (146) $ 59
Basic and diluted earnings (loss) per share ....... $ 0.92 $(2.65) $ 1.07
We issued a one-time founders' grant of options in connection with our
initial public offering to all non-management employees to purchase 100 shares
of PBG common stock. We also issued options during the second quarter to all
management employees as part of our long-term incentive plan.
In October, our Board of Directors authorized the repurchase of up to 10
million shares of our common stock. As of December 25, 1999, we made net
repurchases of approximately 5.3 million shares.
50
27
NOTE 20 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH
1999 QUARTER QUARTER QUARTER QUARTER FULL YEAR
- ---- ------- ------- ------- ------- ---------
Net revenues .... $ 1,452 $ 1,831 $ 2,036 $ 2,186 $ 7,505
Gross profit .... 617 785 874 933 3,209
Operating income 42 92(1) 205 73(2) 412
Net income (loss) (3) 20 92 9 118
FIRST SECOND THIRD FOURTH
1998 QUARTER QUARTER QUARTER QUARTER FULL YEAR
- ---- ------- ------- ------- ------- ---------
Net revenues .......... $ 1,340 $ 1,686 $ 1,963 $ 2,052 $ 7,041
Gross profit .......... 563 696 794 807 2,860
Operating income (loss) 39 103 156 (243)(3) 55
Net income (loss) ..... (6) 22 45 (207)(4) (146)
(1) Includes a $45 million non-cash compensation charge ($29 million after
tax).
(2) Includes $61 million of income for vacation policy changes and
restructuring accrual reversal ($38 million after tax).
(3) Includes $222 million for asset impairment and restructuring costs ($218
million after tax).
(4) Includes a $46 million tax benefit as a result of reaching final agreement
to settle a disputed claim with the Internal Revenue Service.
The first, second and third quarters of each year consist of 12 weeks, while the
fourth quarter consists of 16 weeks.
See Note 4 of the Consolidated Financial Statements for further information
regarding unusual impairment and other charges and credits included in the table
above.
51
28
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
To Our Shareholders:
We are responsible for the preparation, integrity and fair presentation of
the Consolidated Financial Statements, related notes and other information
included in this annual report. The Consolidated Financial Statements were
prepared in accordance with generally accepted accounting principles and include
certain amounts based upon our estimates and assumptions, as required. Other
financial information presented in the annual report is derived from the
Consolidated Financial Statements.
We maintain a system of internal control over financial reporting, designed
to provide reasonable assurance as to the reliability of the Consolidated
Financial Statements, as well as to safeguard assets from unauthorized use or
disposition. The system is supported by formal policies and procedures,
including an active Code of Conduct program intended to ensure employees adhere
to the highest standards of personal and professional integrity. Our internal
audit function monitors and reports on the adequacy of and compliance with the
internal control system, and appropriate actions are taken to address
significant control deficiencies and other opportunities for improving the
system as they are identified.
The Consolidated Financial Statements have been audited and reported on by
our independent auditors, KPMG LLP, who were given free access to all financial
records and related data, including minutes of the meetings of the Board of
Directors and Committees of the Board. We believe that management
representations made to the independent auditors were valid and appropriate.
The Audit Committee of the Board of Directors, which is composed solely of
outside directors, provides oversight to our financial reporting process and our
controls to safeguard assets through periodic meetings with our independent
auditors, internal auditors and management. Both our independent auditors and
internal auditors have free access to the Audit Committee.
Although no cost-effective internal control system will preclude all errors
and irregularities, we believe our controls as of December 25, 1999 provide
reasonable assurance that our assets are safeguarded.
John T. Cahill Peter A. Bridgman
Executive Vice President Senior Vice President
and Chief Financial Officer and Controller
52
29
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
The Pepsi Bottling Group, Inc.
We have audited the accompanying Consolidated Balance Sheets of The Pepsi
Bottling Group, Inc. as of December 25, 1999 and December 26, 1998 and the
related Consolidated Statements of Operations, Cash Flows and Changes in
Shareholders' Equity for each of the fiscal years in the three-year period ended
December 25, 1999. These Consolidated Financial Statements are the
responsibility of management of The Pepsi Bottling Group, Inc. Our
responsibility is to express an opinion on these Consolidated Financial
Statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the Consolidated Financial Statements referred to above
present fairly, in all material respects, the financial position of The Pepsi
Bottling Group, Inc. as of December 25, 1999 and December 26, 1998, and the
results of its operations and its cash flows for each of the fiscal years in the
three-year period ended December 25, 1999, in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
New York, New York
January 25, 2000
53
30
SELECTED FINANCIAL AND OPERATING DATA
(in millions, except per share data)
FISCAL YEARS ENDED 1999 1998 1997 1996 1995
------- ------- ------- ------- -------
STATEMENT OF OPERATIONS DATA:
Net Revenues ........................................ $ 7,505 $ 7,041 $ 6,592 $ 6,603 $ 6,393
Cost of sales ....................................... 4,296 4,181 3,832 3,844 3,771
------- ------- ------- ------- -------
Gross profit ........................................ 3,209 2,860 2,760 2,759 2,622
Selling, delivery and administrative expenses ....... 2,813 2,583 2,425 2,392 2,273
Unusual impairment and other charges and credits (1) (16) 222 -- -- --
------- ------- ------- ------- -------
Operating income .................................... 412 55 335 367 349
Interest expense, net ............................... 202 221 222 225 239
Foreign currency loss (gain) ........................ 1 26 (2) 4 --
Minority interest ................................... 21 -- -- -- --
------- ------- ------- ------- -------
Income (loss) before income taxes ................... 188 (192) 115 138 110
Income tax expense (benefit) (2) .................... 70 (46) 56 89 71
------- ------- ------- ------- -------
Net income (loss) ................................... $ 118 $ (146) $ 59 $ 49 $ 39
======= ======= ======= ======= =======
PER SHARE DATA:
Basic and diluted earnings (loss) per share ......... $ 0.92 $ (2.65) $ 1.07 $ 0.89 $ 0.71
Cash dividend per share ............................. $ 0.06 -- -- -- --
Weighted-average basic and diluted shares outstanding 128 55 55 55 55
OTHER FINANCIAL DATA:
EBITDA (3) .......................................... $ 901 $ 721 $ 774 $ 792 $ 767
Cash provided by operations ......................... 718 625 548 451 431
Capital expenditures ................................ (560) (507) (472) (418) (358)
BALANCE SHEET DATA (AT PERIOD END):
Total assets ........................................ $ 7,619 $ 7,322 $ 7,188 $ 7,052 $ 7,082
Long-term debt:
Allocation of PepsiCo long-term debt ............. -- 3,300 3,300 3,300 3,300
Due to third parties ............................. 3,268 61 96 127 131
------- ------- ------- ------- -------
Total long-term debt ........................... 3,268 3,361 3,396 3,427 3,431
Minority interest ................................... 278 -- -- -- --
Advances from PepsiCo ............................... -- 1,605 1,403 1,162 1,251
Accumulated other comprehensive loss ................ (223) (238) (184) (102) (66)
Shareholders' equity (deficit) ...................... 1,563 (238) (184) (102) (66)
(1) Unusual impairment and other charges and credits is comprised of the
following:
- - $45 million non-cash compensation charge in the second quarter of 1999.
- - $53 million vacation accrual reversal in the fourth quarter of 1999.
- - $8 million restructuring reserve reversal in the fourth quarter of 1999.
- - $222 million charge related to the restructuring of our Russian bottling
operations and the separation of Pepsi-Cola North America's concentrate and
bottling organizations in the fourth quarter of 1998.
(2) 1998 includes a $46 million income tax benefit in the fourth quarter for
the settlement of a disputed claim with the Internal Revenue Service
relating to the deductibility of the amortization of acquired franchise
rights.
(3) Excludes the non-cash component of unusual impairment and other charges and
credits.
54