Coca-Cola Femsa SAB de CV (KOF) 2002 Q4 法說會逐字稿

Good day ladies and gentlemen welcome to Coca-Cola FEMSA's fourth quarter 2002 conference call. At this time, all participates have been placed in a listen only mode. My name is Alicia and I will be your coordinator today. If at any time during the call you require assistance, please press star, zero and a coordinator will be happy to assist you. As a reminder, this conference call is being recorded.

During this conference, call management discuss certain forward-looking statements concerning Coca-Cola FEMSA future performance and should be considered as good faith estimates made by the company. These forward-looking statements reflect management’s expectations based upon currently available data. Actual results are subject to future events and uncertainties which could materially impact the company’s actual performance.

I would now like to introduce your host for today’s call, Mr. Hector Trevino, Chief Financial Officer for Coca-Cola FEMSA accompanied by Alfredo Fernandez, Head of Investment Relations for Coca-Cola FEMSA. Mr. Trevino, please go ahead.

Good morning and welcome to Coca-Cola FEMSA's conference call to discuss our year-end and fourth quarter 2002 results. I am pleased to inform that we achieved outstanding results in the face of yet another challenging year. Our Mexican beverage sales volume surpassed 500m unit cases for the first time in our company's history. And our Mexican operations' EBITDA margin reached 32%. Our highest annual profitability level ever.

Our Argentine operations boast positive results with a positive EBITDA margin of 16.4% despite the worst economic crisis in Argentine history. This exceptional performance growth will improve consolidated results.

Consolidated sales volume reached 620m unit cases. Consolidated EBITDA margin to total revenues of 30.7%. Consolidated net income margin to total revenues of 14.6% and consolidated net income reached the equivalent of $244m.

Originally after our recently announced agreement to acquired Panamco, Moody's Investor Service and the Standard & Poor's reconfirmed our investment grade ratings of BAA2 and BBB respectively. The reasons for the credit rating included our strong business profile; our superior market presence across our market territories; the support of the Coca-Cola Company; and the operating synergies that we expect to achieve from the post-merger integration of our Mexican operations. With approximately 80% of the combined company's 2002 proforma EBITDA coming from Mexico.

In December 2002, we entered into an agreement to acquire Panamco, a Panamain corporation that produces and distributes Coca-Cola products in its bottling territories in Mexico, Brazil, Venezuela, Colombia, Costa Rica, Guatemala, Nicaragua and Panama.

Once it closes, the transaction is expected to make us world's second largest Coca Cola bottler and the premier bottler of Coca-Cola products in Mexico and Latin America. With estimated 2002 proforma revenues of around $4b. Estimated 2002 proforma EBITDA of $930m. And estimated 2002 proforma bottle sales volume of 1.8b unit cases.

Together we expect to account for approximately 50% of Coca-Cola's business in Mexico and close to 10% of it's worldwide volume. And we expect to almost double our revenue based on our sales volume in Mexico.

Once this transaction is closed our immediate priorities will be to put in place the right local strategy; to transfer and replicate core competencies; to reduce debt; and to implement measures to which we expect to realize important cost savings from the post-merger integration of the Mexican operations.

We have already begun the integration process with Panamco's current management. And we feel it is progressing better than we could have possibly envisioned. Both companies have made all the required filings for this transaction and we have secured the financing needed to complete the deal. We believe all the necessary steps to complete the transactions are proceeding as planned. And we expect to close the transaction in the second quarter of this year.

Our Mexican operations performed very well during the fourth quarter of 2002. More and existing carbonated soft drink flavors generated more than 50% of our incremental sales volume during the quarter. Ciel, Coca-Cola's still and mineral water brand contributed to around 35% of these sales with a strong support of our new 5 liter presentation, which cost 1.9m unit cases during the [indiscernible].

The balance came from the remaining brands in our beverage portfolio. During the fourth quarter of 2002, Cola volumes decreased 0.7%. However, they increased approximately 0.8% during the full year 2002.

We believe that it's growing trend will resume during 2003. Because in the last week of January of this year, we began rolling our 2.5 liter returnable [indiscernible] presentation for brand Coca-Cola in the Valley of Mexico.

We have identified an opportunity to strengthen the price point and increase the per capita consumption of brand Coca-Cola in family sized presentations. So far we are the only Coca-Cola bottler in Mexico to launch this specific presentation, which will narrowly replace our 2 liter returnable [indiscernible] presentation. That represented 27% of our total 2002 sales volume in the Valley of Mexico.

This presentation will not only help us to increase per capita consumption and to grow brand Coca-Cola significantly. But also create a strong barrier for B-brand producers in Mexico. The positive performance of Mundet exemplifies Coca-Cola FEMSA's capability to effectively manage a strong soft drink brand with limited marketing support. Through our extensive distribution network.

Mundet reached 13.8m unit cases in 2002 and we feel confident about Mundet's future growth potential. We are working closely with the Coca-Cola Company to design and execute an integrated water strategy. Including the rollout of individual and multi-serving presentations. Since October of last year, we have launched or modified four different non-returnable packaging presentations.

A 5 liter pp presentation which leverages our extensive distribution network targeted the take-home market. Our 1 liter pp presentation with a sport cap that targets the sport venues; a 12 ounce pp presentation for the premise or restaurant channels; and an outsize 600ml presentation in lieu of our existing 500ml bottle, which effectively complements our recently launched 12 ounce presentation for restaurants.

We believe that the still water segment offers significant growth opportunities by increasing our market presence and by capturing part of this continuous growth.

On December 28th of 2002, we implemented a weighted average nominal price increase in the Valley of Mexico of approximately 2.5%. We identified pricing opportunities in individual presentations that target immediate consumption occasions.

Originally on February 13th of this year, we also increased the price of our 5 liter Ciel water presentation by 20%, from Mex$10 to Mex$12. Our specific pricing strategies underscore our company's ability to act on our knowledge and understanding of the many different consumption occasions by channel.

In our industry size matters. But when you combine state of the art production and the information systems, efficient distribution, superior brand equity and experienced management, size is exceptionally powerful. All these strengths provide us with the flexibility to capitalize on market opportunities regardless of the competitive landscape and the configuration of the distribution channels.

Now moving to Argentina. Our value [inaudible] brands and our core brands affordable presentations. First work to minimize the impact of the difficult economic situation. Our introduction of [indiscernible] in multi-serving presentations afforded our consumers a more compelling value. Allowed us to compete more effectively in the low-price soft drink segment and re-enforce our core Coca-Cola brand equity.

Now our strategic shift to return our presentations has enabled us to not only to address changing buying partners and consumer preference in the wake of the Argentina peso devaluation. But also to maximize our profitability and to increase our market presence.

The more difficult economic environment is fueling demand for our core brands in returnable packages. Launched in May 2002, our 1.5 liter returnable glass presentation reached 16.6% of our total sales volume in the fourth quarter of last year. And we believe there is an opportunity to explore more returnable packaging presentations in the future.

In 2002, we continued to stretch the limits of innovation Argentina. We rapidly modified our equipment to increase our operating flexibility. We also implemented value creation initiatives that reduce our selling expenses and our response to dollar denominated inputs. All told, these initiatives increased our EBITDA margin from 15.6% in 2001 to 16.4% in 2002.

Despite a difficult year, we were able to achieve our EBITDA target of Arg$75m pesos. This strength of our BS is impressive. For the first time in our history, we ended this year with a cash position of $590m. This cash combined with our free cash flow generation in the first quarter of 2003 will help us finance part of the Panamco acquisition.

All of the achievements underscore our people’s [inaudible] knowledge and expertise of that diverse and dynamic and developing markets. [Inaudible] see an opportunity for growth in Mexico and elsewhere in Latin America and our flexibility to create value in a rapidly changing consolidated industry landscape.

Our company is driven by results. We know investors look to us to generate superior returns with acceptable risk. And we never lose sight of that fact. With that in mind the acquisition of Panamco is a lifetime opportunity for Coca-Cola FEMSA. Together, we will make a very powerful enterprise. Even better positioned to deliver a sustained shareholder value now and well into the future.

Thank you for your attention. Now I would like to open up the call for any questions that you may have.

Ladies and gentlemen if you wish to ask a question, please star followed by one on your telephone. If your question has been answered, or you wish to withdraw your question, please press star, two. Again, star, one to begin.

The first question is from Pablo Zuanic with J.P. Morgan. Please go ahead sir.

Good morning Hector. Just a question in terms of the new strategy of the 2.5 liter returnable. I just want to understand what is this going to do to you revenue per case and whether it will mean for your EBITDA margins in the first quarter? I assume you will announce first quarter results before the merger because the merger will not close until the second quarter as you said. Specifically what I am looking at, you have an increase of 2.5% in the Valley of Mexico for the single serves, but if the 2 liter returnable was about 27% of the mix, that means about a 6.7% decline in the Valley of Mexico? Which for all of Mexico would mean about a 3.2% decline? How is that going to be compensated and what will it do to EBITDA margins in the first quarter? If you can give us some color on that? Thanks.

Yes good morning Pablo. Again the main strategy behind the 2.5 liter returnable presentation and just to clarify some points so everyone is following the same information. This presentation is only being introduced for brand Coca-Cola. Not for Coca-Cola Lite, not for any flavor. In market analysis what we have found is that for the lunch or dinner occasion which is Mexican families is customary to drink Coca-Cola, the 2 liter presentation is not enough. And we were losing an opportunity there in terms of increasing the revenues per capita of brand Coca-Cola.

So we believe that there is a great direct opportunity for that package to be introduced. Now the price at which it is being launched and as I mentioned during the conference has been rolled out on the specific assumption of Mexico City. When you are doing a change in presentation and a returnable package, it's very difficult and it's different from what you have to do when it's a one-way package. I mean a one-way package, you just start selling the new package and you don't have to worry about exchange in the bottle that is in the trade, the empty bottle. With the 2.5 liter presentation, what we are doing is going to our client which is the retailers, exchanging on a bottle-by-bottle basis the old package for the new package, they just have to pay the new liquid and we are also doing some promotional activity on the houses. And also that we are sure on the specific areas of Mexico City, the change is totally complete.

The price at which we are doing this is at the same price as the 2 liter. So when you look at on a per unit case basis, clearly the price of that presentation will convey a lower price per unit case. There are two points here. One which is very important is that we believe that the revenue, the total revenues that the company will receive will more than compensate by the increase in volume. Because again, as the consumers are moving on a bottle-by-bottle basis, they are basically drinking or buying this extra 25%. So even although the price on a per unit case basis will be smaller at the beginning, we believe that the volume trend will more than offset that fact.

On the cost side, the cost of producing and selling the 2.5 liter returnable pp presentation is very similar to the 2 liter pp presentation. Again because the main component of the cost is the [inaudible] cost that we pay to the Coca-Cola company and because having the same price per bottle that remains exactly the same. The label and the cap is exactly the same. The bottle is slightly more expensive because it's almost the same, it's one or two grams more in [indiscernible]. So it's basically insignificant.

Really the only component that increases slightly our cost of production is the sugar content that we have in this extra half liter. So from that perspective, we do believe there is a very powerful proposition for Coca-Cola FEMSA. Now the second element here is that this is the introductory price. And by also starting to move some of the individual [inaudible] presentations, what we are really doing is also preparing the land for a increase in the price in the future on that presentation.

We do believe that staying with a 2 liter presentation would have implied lost volume as I explained because of the consumption occasion during lunch and dinner and would also imply a very difficult pricing situation going forward, given the competitive environment that we have. The fact that we are introducing this presentation with a larger content, we do believe that will give us the opportunity or the flexibility to start improving the price of that presentation in the future.

As to the first quarter Pablo, it's very difficult to predict that. The rollout is going as I mentioned and it's important to mention that the rollout will be finished by the end of the second quarter. So it's not present in all of Mexico City as of this moment. But in the places where we have it, the volume boost that we are getting is tremendous, really tremendous.

Thank you very much. That's very useful.

Thank you.

The next question is from Robert Ford with Merrill Lynch. Please proceed.

Hey, good morning guys and congratulations on a great fourth quarter. I had a few questions actually. And the first was just to get a sense of what is going to happen post-merger, specifically with your capital expenditure plans and your dividend policy going forward?

Good morning Robert. Let me first address the Capex question. When you look at the two companies pre-merger, Coca-Cola FEMSA was basically spending I would say around $80m in Capex plus some additional Capex in coolers and cases of bottles and cases. Which basically would take the number close to $120m on a yearly basis. That's for [indiscernible]. In the case of Panamco, our analysis from what we have been doing in the past, the number was slightly higher than that, probably closer to $150m.

So that would basically take you to somewhere around $250m to $270m on a combined basis. We do believe that given some of the changes that we need to implement for these synergies to start materializing and to turn around the situation in some of the markets in Panamco. We do believe that in the first three years, we should increase the level of Capex closer to $350m for the first three years. After that, we do believe that a normalized Capex program should be somewhere around 6% of revenues.

One point which is important here is that in the negotiation process with the Coca-Cola company, Panamco and Coca-Cola FEMSA, one of the agreements or the understandings that we had is that as we approach some of the difficult markets like Venezuela, Brazil or Colombia that we will analyze the level of capital expenditures needed to start bringing some growth and profitability into the market, into these territories. And that even the fact we expected these investments to be significant, that the idea is that we will share the pain if you will of these investments after analyzing together what needs to be done in these markets.

The Coca-Cola company was receptive of that proposition. I mean we have not agreed to a specific portentous of how to share these investments. But the general concept is that as we approach these markets we find that there is a specific effort, extra effort needed in order for us to turn around the situation in this market that we will analyze together the level of investments and that we will share proportionately to the respective benefits, the investment needs.

With respect to the dividends. We did have a Board Meeting on February 6th and Coca-Cola FEMSA proposal to the Board Directors was that during this year and up to the moment we fully repay the bridge loan, that we should not be paying any dividend and that proposal was accepted by the Board of Directors. The idea that we have is that we will take this proposal to the Shareholder's Meeting which is March 7th but my feeling is that we will end up with that specific proposal for this year, for 2003.

After the bridge is repaid, which we expect, I mean the bridge is for one year after the financing takes place. So at the most, we will be saying April 2004. After that, and I do expect that 2004 we will resume our normal dividend policy of 20% of the prior year net income.

Great thanks. And then the $350m number for the next few years, that excludes this consideration of the share gain that you would have with the Coca-Cola company in Venezuela, Brazil or Colombia. Is that correct?

That's correct. That is 100% of the capital needed for our preliminary plans for the new company.

And this would address some of the needs I heard mentioned with respect to the move towards more super bottling plants, similar to what you have in [indiscernible] to replace existing infrastructures? Is that correct?

Yes.

Okay. And then one last question, I may have been longer than I anticipated. When you look at some of the merger synergies and the investments that you are going to have to make and the expenses that you will incur, can you give us an idea of the magnitude of those, maybe some line items and what will be capitalized and what will be expensed please?

Yes. With respect to the synergies - what we have and let me just go back a little bit back in time. We have based a lot of the synergies on the analysis that was prepared by Accenture back a couple of years ago, when both companies, both Panamco and Coca-Cola FEMSA, we hired Accenture to help us understand the potential synergies of the Mexican operations, if were to do some production or distribution together.

After reviewing that analysis and updating that analysis we concluded that from the pure synergy's point of view, that means savings or improvements in the efficiencies that are caused by the fact of joining the two companies, that number is around the $70m figure that we have published. And we also think that if we start as we move to improve some of the efficiencies in distribution and the how to go to market practices, that we believe we have. Like for example improving the number of cases per truck or the number of cases that is being handled by a specific warehouse in some of the Mexican regions. We do believe that with this best practices, that we could also improve the Panamco results by somewhere around $50m.

That again is related basically to taking Panamco to some of the efficiencies that we have basically in the South East of Mexico. So that would bring the total to around $120m. Now not all of them will be realized immediately. Clearly the immediate synergies have to do with some [inaudible] and procurement and something that is related to system and production and what I just mentioned about distribution and commercial practices will take a little bit more time and they will require some investments. But that is basically the framework that we are working with.

With respect to some of the expenses. The idea that we have and we have not finalized that, but I will give you my perspective here is that some of the expenses that are directly related to acquisition, for examples fees to lawyers and investment bankers and things like that. We believe that that will part of the acquisition ticket and therefore that will be capitalized. We are analyzing other expenses that have to do with severance and things like that, which we do believe also that will be capitalized. But we have not finalized chapter with the auditors yet.

Okay then, we'll stay in touch and try to get a sense of how things develop. Thank you very much though.

Thank you.

The next question is from Lore Serra with Morgan Stanley. Please go ahead.

Thank you. Good morning. My first question, I just wanted to ask a few procedural issues. You mentioned that the rating agencies confirmed your ratings. Can you just give us a sense of the timing of that? You mentioned you had closed the financing, can you give us a sense of the terms? And lastly, you mentioned that you expect to close in the second quarter. Can you give us any update in terms of the comments from the SEC on the proxy? That's my first question.

Okay Lore. Let me starting with rating agencies. We basically what I mentioned here is the latest analysis of what is prepared by these two companies that was prior to the announcement on December 23rd. We have been in touch with them after that and we have not received any communication or any sense that that rating might change. So we feel still up to this moment that is the rating that we have.

The other question has to do with the financial. What we have is a commitment in place from Morgan Stanley and J.P. Morgan. We have gone through the syndication process. We have already commitments from three additional banks that are participating at what we call the senior arranger level. And as of last week, we started the next step in the syndication process which is going to the arranger level. Everything is advancing fine in that respect and the terms that we have is basically we have commitments for term financing for $500m. At a rate that will start at level plus 85 basis points for the first three years and then is level plus 95 basis points for the fourth year and level plus 105 for the fifth year on this term financing.

The rest of the financing, the cost of that is at level, I don't know, it's plus one and it goes to level plus 2.5 on the last quarter of the first year. So it's a step upgrade that starts in level one and [indiscernible] level plus 2.5.

I'm sorry Hector, I thought you were trying to take out some for the bridge loan with peso financing and I was wondering what the indicative terms were for that peso financing?

Let me just finish. So what we are doing and this is something that is kind of moving targets. We have received for the term financing and for the bridge financing, we have received firm commitments in pesos by two institutions. So we already have commitments for $500m, the equivalent of $500m in pesos. Out of that $300m is for the bridge and $200m is for the term financing. So we already have commitments for let's say $200m, the equivalent to $200m in the term financing at conditions that if you were to swap the peso rates at this moment is exactly the same as the rates that I have just mentioned.

In the case of the re-financing. If you were to swap the peso rates it would bring some savings versus the rate that I just mentioned of level plus one. And we are working also with the idea of potentially refunding some of these needs as early as this coming month of March in the peso market. The idea behind that is again the idea of trying to diversify our exposure on this financing in a large proportion to Mexican pesos which is again where we are going to derive 80% of our cash flow.

And also the idea that in the case of Mexico, we can go to the market and place this bonds in Mexican pesos without the need to prepare proforma financial statements of the two companies combined which as I have expressed in the past is a task that will take some time to finalize. To finalize the numbers under Mexican GAAP. So basically at the end of the day what we are expecting right now is that potentially let's say that everything works as planned we will have $200m in the permanent financing, in the term loan financing at least $200m in pesos. And somewhere around the equivalent to $600m to $800m in the Mexican market with the [inaudible] and the pension funds.

The third question has to do with the timing of the --?

Yes and if there is anymore specific timetable you can give us in terms of the closing?

We have received comments from the SEC, basically that we had a conversation with them last week. They are reviewing the process, so we already discarded the possibility of going through, let me call it the fast track process where it will be a no review process. So they are reviewing that. And we do expect that we find out on January 30th and the information we have is that it will take from 4 to 6 weeks for them to come back to us.

So that will take us basically to the middle of March and if everything is fine in that review, then we will be immediately calling a shareholder meeting for Panamco and we will have to provide 20 business days which is basically one calendar month for the shareholders meeting to take place. And immediately after the Shareholder Meeting we close assuming that everyone votes in favor or the majority of the shareholders vote in favor of this transaction. That is basically the steps that we have. If we try to put dates on that, basically that will take us to the second half of April for closing.

Okay and back to the operating results for a second. In the quarter in Mexico, we saw a fairly sizeable contraction in your gross margin. I'm sure some of that was due to raw material costs, but I want to understand a bit more behind that as well as the decline you had in selling expenses that offset that. And I am wondering if there was something special in the fourth quarter at that level is sustainable?

And then I guess more broadly, you announced in your press release that you are not giving any guidance and I can understand that given the complexity of consolidating Panamco. But I wondered if you could give us any thoughts in terms of sort of the core operations in Mexico, you know what the outlook would be this year without any acquisition?

Yes. With respect to the gross margin, we did have some impact because obviously as oil prices have increased, we have received some price increases with respect to BT and also remember that because of the introduction of the five year presentation and the fact that we did reduce the price of some of the flavor presentations during the fourth quarter. That we have already taken back to the prior levels, that happened at December 28th. So that has some impact there on the margins, no?

With respect to the guidance. The idea that we have Lore is that we will continue to provide a very ample disclosure as I think that we have worked and that we have earned a reputation for the last almost 10 years now, since we make public of being a very open company in terms of the information to the shareholders. I think that to start providing guidance at this moment in time is kind of very complicated. We have a lot of moving parts. What I can tell you right now is that we do believe that the strategies that we have implemented with respect to the new water presentations, especially the 2.5 presentation returnable ability will provide in our estimates, will provide volume that will compensate for this, if you will, called lost revenue per unit case. But that's as much as I can provide at this moment.

Okay. And just to follow-up. Was there anything extraordinary in the quarter in terms of the selling expenses? Could you comment on why the selling expenses came down 13% in the quarter or 14% in light of the fact that you did higher revenues?

No I think it's nothing important. It's just the fact that some of the efficiencies that we have introduced in the distribution, remember that we started with a first wave of a few years ago of our production master plan. And now we are at the end of this distribution method [inaudible]. We did have some efficiencies or some small reductions in the marketing expenses at year-end that had more to do with finalizing in our budget that we are anticipating. But I don't recall anything specific to notice with respect to selling expenses.

At the end of the day our marketing expenses are ending up around 4.2% of revenues. So we did adjust a little bit the numbers in the last quarter of some of the numbers that we had in the first three quarters might be ahead of the total budget for the year.

Okay thank you.

Thanks Lore.

The next question is from Navir Sudio(ph) with ING Bank. Please go ahead.

Hi there, just going back on the previous comments on the process. You are implying that the close of the deal will be sometime in the second half of April. Are you therefore implying that you will close the deal before you get confirmation from the Brazilian Antitrust Authorities?

Yes. Let me tell you what is the issue with this. We have as we announced, the U.S. Antitrust and we have two processes going with respect, one is Mexico and the other is Brazil. In the case of Brazil, there is no specific need for us to wait for that confirmation, it's just that we have to prepare the finding for that. It's not something that is required for us and since we don't have any specific operations in Brazil, we are not envisioning any problems. So we will close even we don't have that Brazilian Antitrust clearance.

In the case of Mexico, again given the importance of Mexico, we do need to wait for that clearance. Because obviously Mexico is a very important piece of the total equation. What I am saying with the second half of April that we envisage closing and finalizing the Antitrust process in Mexico before that date. But we do need to clear that with Mexican authorities. In other words it's a condition to the transaction that we have a final clearance on Mexico before closing.

Okay thanks, great thanks.

In addition, we have had conversations with those authorities as we find and we are not envisaging any problems. Again, these are different geographic territories and it is not the same case as buying a competitor in the same geographic area. And we have plenty of occasions in the past where some other bottlers have been acquiring territories, like in the case of PB [indiscernible] acquiring some other territories or in the case of the formation of Arca which is the Coca-Cola bottler in the North the was also approved by the authorities, no.

Okay, that's brilliant. Thanks.

The next question is from Michael Verra, an Independent Analyst. Go ahead.

Good morning Hector. How many cases of [indiscernible] that were sold in 2001, you gave the number for 2002?

Hello. Hi Michael. I don't have the exact number but I will give that to you later. The growth was above 100%. So it would have been somewhere around 6m unit cases or somewhere around that. It was slightly above 100% increase.

Okay. Hector, I think you just mentioned just to clarify that when you were addressing Lore's question about the gross margin, that you had re-priced or taken the pricing back to prior levels on the flavors on December 28th? You went down and then you went back up December?

In some of the presentations, yes. We came back and I can give you some examples.

Michael, this is Alfredo Fernandez how are you?

Hi Alfredo.

Well you've got to remember we are talking about the can presentations.

Okay, not the 2 liters?

No, no. The can presentations, I mean the price and it started to come down in October and we finished in November. So we were not talking about the 2-liter presentation.

Okay, that's where my confusion arose.

Sorry about the confusion. Basically what I was trying to say is that in December 28th, we did increase the price of cans on flavors from Mex$3 to Mex$4 again. Which in the case of cans is $.50 below the Coca-Cola price. But that was part of the effect that we had on the fourth quarter with respect to margins.

Okay. And after the launching price for 2.5 liters is Mex$14 correct?

Yes.

And I hear that Pepsi and I don't know if it's [inaudible] but there is some reaction already with their 2 liter [inaudible] at Mex$10. Are you seeing this in PBG costs over [inaudible] territories like Mexico City?

Yes remember that what we have seen is that in some specific areas not in the whole Mexico City, they have reduced the price of their 2-liter presentation which is one way from Mex$12 to Mex$10.

Right. So it's a one way they reduced to Mex$10?

Yes, because they almost -

Yes they dissipated -

They returned our presentation. And just to clarify Michael, the 2-liter non-returnable flavors in our case, for Coca-Cola flavors our price is Mex$12. Okay? So just to clarify the last question. The Coca-Cola price for 2 liter one-way is Mex$14.

Now is it fair to say that if PBG for some reason were to be maintained as Mex$10 which seems unsustainable, but if they do keep it you won't be able to take pricing in 2003 as you were planning with the 2.5 liter pack?

Yes I mean that's the right assumption. I think that in general, I mean we need to be very careful when we move prices, no? I mean we have to check the competitor’s price architecture.

And just to clarify Michael. I don't know if I shared that one. The 2-liter returnable presentation for brand Coca-Cola is Mex$12 and we are launching the 2.5 at the Mex$12. The one that is at Mex$14 is the 2-liter one-way.

Okay. And just a final question on the CFC because you made a comment in your press release. I mean is there any chance that this whole litigation was somebody's baby is no longer and that maybe under PBG, Pepsi may be more willing to explore alternatives to settle the issue outside the court?

I don't know Michael. I mean my conversation with the lawyers that are following this case, they see this is a very long process. And again just to reiterate in our case, less than 2% of our clients, or less than 1%, I don't remember exactly the numbers. It's less than 2% by sure, of our clients have some kind of exclusivity agreements. So we do believe that, and some of them have to do with [indiscernible] and amusement parks where Pepsi Cola is doing the same thing. So we don't think that we have a conflict here.

In the case of Mom & Pops which is the case where they are complaining about, or the Commission or the CFC is focusing, it's very limited the number and again I don't have the exact number in place, but I think it's less than 1% of our clients.

Now at some point in time the bottlers that were calling the Commission to complain about that. They were asking for some damages. The Commission is not so far, they have not accepted that damages should be awarded here. So Pepsi Cola is also going into this [indiscernible] or this procedure, to ask the Commission to change the preliminary findings that they have, no.

So I don't know. If everything goes by the right, by this legal procedure, it will take several years to finish. So I am not sure about the possibility of getting to some kind of outside of court settlement.

Thanks Hector.

Thank you Michael.

The next question is from Alex Robarts with Santander. Go ahead.

Yes, hi good morning. I wanted to go back to Mexico as well and ask about the interesting divergence of growth we saw with the operating incomes in the EBITDA. So I guess kind of maybe if you could help us understand, it seemed that in the fourth quarter in Mexico you had a very sharp drop in the non-cash expenses, about a 25% drop. And looking back at the third quarter that was twice as much as the drop that we saw then of 13%. I mean is this a one-off drop here or is this rate of non-cash items going to be more indicative of what we might see for the year?

Good morning Alex. Remember that in 2002 we were announcing some write-offs that we had? We specifically closed down two big warehouses in the fourth quarter 2002 that we can base on write-offs there. And that remains the explanation for this.

Okay.

I mean in general, 2002 we had a cleaner from the write-off perspective year. Obviously setting aside what we did with Argentina in the third quarter was a big impairment charge. But with respect to you know closing facilities, remember we moved a number of plants and a number of warehouses importantly during the year 2000 and 2001.

I don't think we have that much of a divergence in these numbers going forward. But in this specific case that was basically related to two big warehouses that were shut down in Mexico City in the fourth quarter 2001.

Okay. That's helpful. The other idea really related, and I know you can't give too much of a guidance here on potential price increases of the upscale volumes. And clearly we have to see what goes on with Pepsi. But I guess the movement, if you were to consider one, is it safe to assume that any type of price increase would happen in the second half of this year?

And then kind of thinking about really what would be the rough timing of when you would approach upscaling these 2-liter formats post acquisition in the Panamco territory? And kind of just wrapping that all up together, with the idea of just confirming where and at what levels are we seeing Cola Reale currently in your territories and is it still a kind of 0.5% point of sales penetration level and if you could talk about that? Thanks.

Obviously as you correctly pointed out, the pricing, obviously it's very sensitive and something that we need to manage very carefully and clearly something we need to watch how our competitors start adjusting prices going forward for us to start deciding when to move the prices.

If we were to find no movement from some of the competitors and Pepsi going back to the same prices that they had in 2 liters or Pepsi moving to 2.5 liters. Then we probably will have a bit more room to maneuver with respect to the pricing of these 2 and 2.5 returnable pp presentation. But that is kind of, it is very difficult to predict at this moment.

We are not putting this presentation in the Southeast of Mexico, we believe we will stay with this presentation in Southeast of Mexico because again one of the reasons why we have this 2.5 presentation is the consumption occasion that we are seeing at lunch and dinner in the Mexico City families. And we need to finalize our analysis of the Southeast before deciding to move.

And again, we believe also it is a clever way of addressing the cost of doing this change by using the bottles that we are taking out of the Mexico City markets and using that in the Southeast, as opposed to just destroying the investment that we have into the returnable pp bottles in Mexico City.

So it will be more like a gradual movement, if we find the opportunity to move to 2.5. I mean at the end of the day we have not made a final decision with respect to the Southeast.

In the case of Panamco, we do believe that in some of the large cities like Leon or [indiscernible], there might be an opportunity for the 2.5. We need to finalize our analysis, we have not finalized that yet Alex. But we potentially could find space in the large cities that Panamco has for this format.

With respect to Cola Reale; they have continued, when you go to the traditional Mom & Pop market, they have continued to have very small penetration, less than 1%, as we have expressed. We monitor that basically every week. Every week we have the information about and what percentage of our retailers that we cover which is conceptually close to 100% of the retailers that there are in Mexico.

What percentage of those retailers are carrying Cola Reale and continues to be below 1%. The movement that they have been doing is that they are going to the supermarket channels and now you find Cola Reale in some of the supermarket chains [inaudible] Mexicana and [inaudible]. It is not present in Wal-Mart.

We might end up finding Cola Reale in [indiscernible] which is [indiscernible]. But at the end of the day [indiscernible] performance were given on a bottle-by-bottle basis as you have to buy the whole case. So it's more a case of where potentially where retailers and buy for their own small stores.

So this is a movement that they have done recently so they are now present in some of these supermarkets, but again remember that supermarkets is a very small part of our mix of volume, no.

Okay. And where I was going was just in the Panamco territories thinking about Cola Reale, if it's not you haven't set or pinpointed the exact opportunities of the upscaling if you kind of consider that a strategy or building a barrier to entry for those Cola Reale.

Would it then be safe to say how you go after those guys in the Panamco territories and it's going to more replicating the efforts of bundling products with oil and such or being more effective in terms of your rationalization and such? Is that going to be basic initial strategy against Cola Reale in the Panamco territories?

Well clearly, obviously the strategy is already what we have been using which is the bottling of these products and/or this 2.5 presentation, 2.5 liter returnable presentation.

Okay. Alright thank you.

The next question we have is from Brett Patelski(ph) with Tidaman(ph). Go ahead sir.

Yes, hi. I have two questions, one of which might have been covered. I just wanted to get a little bit more specific. Is there any point in which if the peso keeps going down, you know economically, the Panamco price doesn't make sense or you might rethink the prices, because you get hit two-fold one on the financing and two on the fact that some of their costs are fixed in U.S. dollars. So as the peso goes down you get squeezed that way as well.

And secondly, could you just in a little more detail exactly the financing? Because you had talked earlier about $500m I guess part. But I thought you need a couple of billion in financing? So I was just trying to understand exactly how that works?

Yes thank you. The peso dollar exchange rate clearly is a variable that has an impact on the economics of this industry. Because as you correctly pointed out to have a portion of your raw materials, which is basically [inaudible] and aluminum are dollar denominated.

We have agreed with Panamco that we don't have an exit on this position because of the movement on the exchange rate. Because again at the end of the day, as you are here for business on a longer term business. You know that in Latin America you would have some movements on the exchange rate or growth or whatever. So we don't have an exit from this transaction because of the peso dollar exchange rate movement.

With respect to the second question. Let me try to breakdown some of the financing. We have a commitment in place for $2.05b. Out of that we have $500m as a term financing. So from the very beginning will already be long-term. And the remaining which is $1.55b which will be in a bridge for one year.

That $1.55b is going to be refinanced and what I was telling everybody at the beginning, we are trying to pre-form part of that, by pre-form meaning before April, with some Mexico peso bonds. So we are anticipating that during March we will do close to $400m in peso financing in Mexico.

And then the remaining, which is basically $1.1b will be refinanced during the following year, either in the Mexican bond market, or in some other kind of financing capital market like the [inaudible] bond or something like that.

We need to bear in mind also that we have offered all the Coca-Cola FEMSA shareholders the possibility to subscribe shares at $22.60 per ADR. That will take place probably in the third quarter, because we need to close the transaction, prepare the financials, do the filings with the SEC. And precisely the purposes of having this writing in place. It will take time for us to prepare all the proforma numbers and the financial numbers under Mexican GAAP.

So if we were to have success under some of these capital, these write offerings, clearly that is a way of also reducing part of the bridge without the need to refinance that. But again, trying to summarize. We have $500m in a term financing, which we have two pieces there, one is a 3 year and the other is for 5 years. We were trying to perform around $400m the equivalent of $400 in peso bonds in Mexico, in Mexican pesos. And depending on the cash balances that we accumulate from here to closing, we might end up needing slightly less resources than the $2.05b that we were originally contemplating.

Okay. I guess so even if the peso continues to depreciate, you are saying there is no way either yourselves or the financing commitments could walk away from the transaction?

The only exit that we have is if the banks are not there because of a material change.

And that would have to exclude any currency movements. Like could a currency movement on the financing be considered?

No, let me try to explain that. In the financing document that we have, that provided the commitments, they do have exists in case there is more of a customized financing. If they see a major change in the conditions in the market, they might say there is some material that they will change so the money is not there.

If that is the case, we do not have the same out in the merger agreement and we will need to pay break-up fee in case we are not able to close because the financing is not there. That break-up fee is $125m.

Right okay. So theoretically if the currency did move to an extreme level, there could be a situation where the financing might use that as a material adverse? But that would probably have to be an extreme move in the currency?

Exactly.

Right. And you had said you had started an initial syndication. Was that of the bridge or that was of the term loan?

It's both. What we are asking is participation in both in the term loan and the bridge. So we already have five banks committed, the two original banks, Morgan Stanley and J.P. Morgan, plus three other banks that have already committed their resources for both the bridge and the term finance.

Okay thank you very much.

The next question we have is from Simon Okicas(ph) with KBC Asset Management. Please go ahead.

I just have two quick questions for you. The first in regard to the financing. Are there any specific liquidity or performance tests regarding receiving financing?

Is the question related to covenants, that we might have going forward with respect to liquidities?

Yes. For example, a covenant regarding your debt EBITDA ratio or any other similar type of --?

Yes. We have not finalized the negotiation of that. But we do have some covenants, financial covenants and that will basically allow us to [inaudible] covenant ratio [inaudible] to total debt. We have not negotiated the ratios. The general concept that we have or the agreement that we have in this commitment is that we will have covenants that reflect the imbedded rate that we have, no. So we do expect some financial covenants to be pretty much in line with a BBB company.

Okay, great. And the second question is, in regard to the modified material adverse change clause. It does mention in the proxy both regarding against the financing and the merger agreement. Can you expand or clarify at all on the base-line component that is mentioned in there? I know there is reference as to one of the schedules, but that obviously wasn't filed. I would just love to hear a little bit more about who was behind getting this modified standard in there and why they wanted there?

Are you referring to the Venezuelan situation?

That's correct Hector.

Clearly the Venezuela situation was something that was evolving as were closing the negotiation. Remember that the strike was there since December 1st. And we were closing this on the 22nd. So the basic agreement that we have, in that Panamco mentioned that, and we reviewed those numbers, the cash bond rate with operations as they were during December, they were borrowing cash around probably $7m to $8m a month.

And just the cost that they had in terms of paying salaries without going and selling products. So I don't remember exactly the formula but we have imbedded that, that situation was going to stay for a couple of months. So the first. let's say $20m were excluded from any material adverse change that basically the idea of this modifying clause.

In other words, we were recognizing that the strike would stay for a longer period and that therefore Panamco would probably go into a negative cash flow for these two or three months you know around, let's say $8m a month, I don't remember exactly the amount but it was something around that. So that piece is excluded from any computation of material adverse change.

Okay great. So it's really just a component of both a time element and there is a cash flow measurement during some set time period.

Exactly.

Okay great.

Just to complement the information, we have been obviously in very close contact with Panamco. They have assumed already some of the operations in Venezuela. Obviously the main problem that they have is their supply of gasoline and therefore the operation is not back to 100%. But they are now active and there is some activity already in the marketplace. So they are not having this rate of depletion of cash, if you will, as they had during December and January.

Okay great. So assuming the strike does not recur, we probably shouldn't return back to the $7m to $8m burn a month?

Exactly.

Great thanks very much.

Thanks.

And we have a follow-up question from Lore Serra with Morgan Stanley. Please go ahead.

Hello?

Go ahead Miss Serra.

Hi, this is just a couple of quick follow-ups. In terms of the pricing and the market of Mexico. Can you just comment on whether the discounting you have seen in terms of the Pepsi products to Mex$10 on the 2 liter. Is that targeted on multi on a supermarket chain or is it broader than that?

And could you just give us a sense of where your introductory price was on 1.75 liter that you launched [inaudible]and that is going to be a pretty targeted launch?

Yes. In the case of Pepsi, what we have found is that they are not in 100% of the Mexico City territory both in some of let's say the poorer areas of Mexico City. And clearly in the supermarkets it has to be more evenly distributed. But we have seen some pricing activity also in the traditional channels, no? In other words we have found that Mex$10 per 2 liters not only in supermarkets but also some in the traditional channels in some areas of Mexico City.

And it is reaching the consumer?

Yes, in some of the cases we have been analyzing? The 1.75 liter which is a Fanta presentation that is really targeted to [inaudible] channel which is a very small percentage of our mix. But where we clearly have a situation with flavors, because there you have [inaudible]we are pricing that Mex$8.50.

Okay. And just briefly in Argentina. I know this has been a long call, but obviously the exchange has strengthened which I guess helps your cost inflation. But could you just comment on the outlook for pricing in Argentina this year? And also to my knowledge you didn't adjust salary levels and haven't been generalized salary increases in the Argentine market since the devaluation at the beginning of last year? Has there been any movement in terms of salary levels, either on your own or in the economy that you have seen?

I will need to get back to you with respect to your answer. I am not sure. I mean I know that we have done some salary adjustments since the beginning of last year. But I don't have all the information with me right now Lore.

With respect to the pricing. As I mentioned during this conference call, one of the ideas that we are looking is the possibility of increasing the number of returnable presentations potentially the 2 liter plastic presentation, is something that we are looking at. So obviously pricing, as we are starting to [inaudible] new presentations is kind of a complicated [indiscernible] to measure because we don't have specific clarities at this moment and at what price we will be able to introduce our presentation. Or if we introduce that presentation at all.

But in general, we do continue to move prices as we find opportunities. I don't have the price list with me at this moment, but we have been increasing prices lately also. And again as find opportunities we start moving a few pennies in each of the presentations. So my interpretation is that we will continue to adjust prices going forward in Argentina. We had a very complicated year in Argentina with the elections. Elections in theory coming in April.

The exchange rate as you correctly pointed out has been leading to this very stable period of appreciation. But at the end of the day Argentina is still in a very difficult situation where they are basically, if you will, caught under Chapter 11 under the creditors. So it's very difficult to predict what is going to happen with the exchange rate and therefore with the pricing in Argentina.

Okay thank you.

The next question is from Brett Patelski(ph) with Tidaman(ph). Go ahead sir.

Yes, I'm sorry its Drew Figdor (ph). I don't mean to beat the horse on the Venezuela question. But I guess I was trying to understand you sort of modified the matt clause and thought about it so much when Venezuela was 5% or 6% of business before and that's before it sort of fell apart. So I was wondering why is it even a consideration if it was already sort of at the bottom? And is there a potential that it could lose a lot more than $8m in different circumstances? Is that the rationale? I don't know if you can help me out?

We still have this concept that in order for us to not close the transaction because of the material adverse change that will have to be something that is material to Panamco taken as a whole. And that is still true. And again Venezuela is a very small portion of the pie of Panamco. As you correctly pointed out it's close to 5%, no.

So it's very difficult to envisage that something in Venezuela will have a materially adverse effect from Panamco taken as a whole. But I guess it was more like given the fact that the situation everyone was nervous about that on both sides. Panamco and ourselves. The uncertainty that what happened at that moment and we just decided to include our original language. But at the end of the day you were to call a material adverse change clause it had to be something that is material for Panamco taken as a whole.

Could it be, I guess my main concern would be that they put in price controls and that had impacted not, it not only impacts this short term $8m a month potential loss that will come back some day and be a great business. But something would be a long-term margin issue. If they did price controls, do you think that would be material development?

What I can tell you is we will start to evaluate at that moment what is the impact of that and [inaudible] that will be material for Panamco taken as a whole. My personal opinion is that at some point in time, we need to see the value that and be sure that we have [inaudible] to call that. But it's difficult to envisage something happening in Venezuela that will have a materially adverse effect on the whole company.

Okay thanks.

Hello Operator?

Yes sir.

We have probably time for one or two more questions.

We have no more questions in the queue sir.

Okay. I would like to thank all of you for your attention that you have for this conference. As soon as we get closer to this transaction we will keep you very well informed of how things are evolving and also it's important to keep the communication open with all of you as to how we are achieving some of the targets that will indicate that things are going in the right direction.

Thank you very much for your attention again.

Ladies and gentlemen, thank you for joining today's conference. This concludes the program. You may now disconnect. Good day.