Coca-Cola Femsa SAB de CV (KOF) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Coca-Cola FEMSA second quarter results conference call. (CALLER INSTRUCTIONS). As a reminder, this call is been recorded for replay purposes. This conference call may discuss certain forward-looking statements concerning Coca-Cola FEMSA's future performance and should be considered as good-faith estimates made by the Company. These forward-looking statements reflect managed expectations that are 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 turn the program over to your host for today's call, Mr. Hector Trevino, Chief Financial Officer of Coca-Cola FEMSA. Please go ahead.

Good morning. And welcome to Coca-Cola FEMSA's conference call to discuss our second quarter 2003 results. Before we start providing detailed information about our operations, I want to highlight that our second quarter financial information includes three months results of the original Coca-Cola FEMSA's territories and only two months of our new territories. Coca-Cola FEMSA's financial information will not be comparable with previous quarters until the third quarter of 2004, and on a yearly basis until the end of 2005. However, we're providing volumes growth information for the three months of the second quarter 2003 and all of our territories' volume growth three years, therefore, are comparable with previous periods. We will continue our commitment to remain at the forefront of corporate disclosure, a quality that is already distinguished us in our industry. Now let me talk about our operations. The past three months have been of tremendous excitement for all of us at the new Coca-Cola FEMSA. We're about to complete our first 100 days running our new territories and we're well ahead in the implementation of a huge transformation process. For example, we have closed four of the 52 plants we had on May 6, 2003 when we finalized the acquisition, including one plant in the Bajio region of Mexico, one in Panama and two in Venezuela. We have also closed 15 distribution centers in the Bajio and Gulf regions in Mexico, reducing them to 82 from 97. We are changing organizational and compensation structures to match them to the operating needs and to the targeted performance standards of Coca-Cola FEMSA.

We have deployed Glennis Patrick (ph) from Mexico and Argentina to our new territories in the areas of Finance, Human Resources, Distribution and Commercialization, reinforcing the existing talent and management expertise of our local operators in Central and South America. We're improving internal controls and confirming quality controls and procedures. Our goal is to replicate Coca-Cola FEMSA's internal control in all of our new territories 18 months from now. As of June of this year, the Valley of Mexico, the southeast of Mexico and Buenos Aires are using exactly the same SAP system platform. We're implementing this same platform to our New Mexican territories. We expect to have it ready during 2004. In July we initiated the rollout of SAP beverage industry solution in two of our distribution facilities in the Valley of Mexico. This initiative should provide room for internal efficiencies because it replaces the old Basis systems as the operating system gathering market information. This initiative will provide us with online marketing information which will enhance our capabilities to implement pricing strategies per SKU and customer. We have been able to refinance the majority of our standing bridge loans. Now 50 percent of our total debt is denominated in local currencies. I'm very pleased with the rapid pace of which the integration of our operation is progressing. In Mexico we're implementing an aggressive restructuring process and developing packaging, pricing and product initiatives that are strengthening our market presence and execution potential. In Mexico, excluding volume generated from promotional activity with powered products last year, volume grew by 4 percent during the quarter. This strong performance was mainly driven by the 3.8 volume growth generated by brand Coca-Cola in the Valley of Mexico, mainly driven by the (inaudible) of its 2.5-liter returnable packaging presentation.

The strong performance of our carbonated soft drink flavored brands in all of our Mexican territories, mainly driven by Lift Manzana Verde Fanta Multi-Flavors. Carbonated soft flavor volumes increased 13 percent in our Mexican territories during the quarter. And also by the strong performance of Ciel Stillwater growing volumes by more than 100 percent in the Valley of Mexico, mainly driven by the incremental volumes of the 5 liter non-returnable packaging presentation. Again, excluding volume generated from promotional activity with powered products last year, carbonated soft drinks flavors generated almost 55 percent of incremental growth during the quarter. Ciel sparkling water accounted for more than 30 percent and (inaudible) was produced by brand Coca-Cola. The Valley of Mexico represented 77 percent of the incremental volumes generated by our Mexican territories during the quarter. The 2.5-liter returnable presentation for brand Coca-Cola is offering a compelling value proposition for consumers, expanding the carbonated soft drink market and reinforcing the brand equity of Coca-Cola. We already initiated the rollout of this presentation in the city of Puebla at 12 pesos with very good results. And we have also started the rollout to this presentations in selected cities in the rest of our territories. Now our new Mexican territories, the Gulf and Bajio regions, we're implementing several pricing and packaging initiatives for distribution channel that should help increase the profitability our portfolio approach and pave the way for the introduction of new SKUs. For example, in the Gulf region we initiated (inaudible) pricing process focusing on increasing prices for the 2-liter returnable presentation for brand Coca-Cola from 10 pesos to 11 or 12 pesos based on economic areas. We anticipate a strong contribution to volume growth from brand Coca-Cola during the rest of the year all over our Mexican territories.

We are also increasing the profitability of our jug water business segmenting our customer base by territories, pricing at a premium jug water delivery versus mom-and-pops. This execution is helping us to increase the pricing range of our Stillwater jugs from 13 to 16 pesos to a pricing range of 17 to 20 pesos. Water volumes remain almost flat in our new Mexican territories, however, they are becoming more profitable due to this higher price range. In the city of Puebla, we have also initiated the rollout of the 5 liter non-returnable presentation for Stillwater brand Ciel. We increased the production capacity of this presentation to better serve the incremental demand in the Valley of Mexico and eventually our new territories. Our Mexican operations reached of 25.6 percent operating income margin during the second quarter, mainly driven by incremental (inaudible) volumes, lower distribution, fixed cost achieved by the closing of the distribution facilities, and initial reduction of headcount overlap to the value chain, and lower corporate expenses derived by the closing of the former Panamco corporate offices in Mexico City and (inaudible). In our Latin Center division that comprises the territory of Guatemala and Nicaragua, Costa Rica, Panama, Columbia and Venezuela, we are developing a strong divisional office in charge of putting Coca-Cola franchise business model in place. We are in the process of implementing internal controls, standardizing system platforms and replicating quality control and maintenance models. Productivity increases and better operating practices need to be in place while manufacturing and (inaudible) assets are being restructured. Once these capabilities are in place we will concentrate on implementing initiatives directed to increase soft drink per capita consumption.

In Central America we will strengthen the market presence of the Coca-Cola Company brands, introducing new packaging presentations and implementing revenue management initiatives to capture more effectively different consumption locations, making soft drink products more attractive for our consumers. We are reorganizing the way we go to market by redesigning pre-sell practices and delivery routes in order to increase the effectiveness and the efficiency of our execution efforts. These initiatives are paving the way for our reorganization of distribution facilities to increase warehouse productivity. Developing the right return on our packaging strategy will strengthen the market presence of our brands in Central America. For example, we launched a 2-liter returnable presentation for brand Coca-Cola in Nicaragua using the packaging presentations that were phased out from the Valley of Mexico. This initiative is an example of the coordinated efforts that our Company can implement, extracting more value from existing assets, developing different strategies simultaneously in several market countries. In Columbia, even though the manufacturing sector of the economy shows signs of recovery, the current economic situation (inaudible) income reducing overall soft drink industry consumption. However, the industry profile of Columbia offers attractive opportunities. It has a low supermarket penetration, low B brand development, a fragmented point-of-sale structure, a rational competitive environment, and the Coca-Cola brands have strong brand equity. All these industry characteristics provide important opportunities for our local management in Columbia to increase the profitability of our operations in that country.

We are currently reevaluating the pricing configuration of our packaging presentations to design the right portfolio approach by distribution channel and consumption occasion in Columbia. We're increasing coverage of our personal sized returnable presentations and adjusting the pricing architecture to strengthen our competitive decision in the market. In Venezuela our Company regained its path to profitability during the second quarter. Operating margins reached 5.6 percent as a percentage of total revenues for the months of May and June. Although total volumes declined 4.6 percent during the quarter, brand Coca-Cola volumes increased double-digit during the same period. Shortly after the significant devaluation suffered by the Venezuelan boliver versus the U.S. dollar our local management implemented a weighted average price increase of more than 55 percent in February to offset the cost increases of U.S. dollar-denominated raw materials. During the same period, as soon as the Company was able to increase point-of-sale coverage, we concentrated our efforts and the restricted availability of raw material supplies in our most profitable brand Coca-Cola. That is one of the main reasons why CSD (ph) flavors and bottled water volumes declined in this territory.

We perceive a rational competitive environment in Venezuela and significant opportunities to enhance the top line. Our Company is concentrating its efforts in Venezuela on developing a balance of returnable non-returnable packaging portfolio presentations to lever the strong brand equity of Coca-Cola, and to diversify its packaging base in order to provide the most attractive value proposition for our clients and customers. We're also implementing raw material management programs reducing waste and increasing production efficiency. Additionally, we are restructuring operating process and reorganizing production lines achieving better production and efficiency standards. Our Brazilian operations represent an important challenge for our Company. Lack of coordination among Coca-Cola bottlers has generated (inaudible) shipments of Coca-Cola products among different franchises, developing a secondary market for Coca-Cola products and, therefore, creating proprietary indirect channels that have depressed overall soft drink prices. Lack of packaging innovation has resulted in a high packaging concentration around the 2-liter PET non-returnable presentation and cans, forcing the Coca-Cola bottling system to play a reactive pricing role in the soft drink industry. All this industry characteristics, combined with excessive selling and distribution outsourcing, poor execution, and lack of investment in the market has generated poor financial results in the past and low personal morale. However, if you walk through the streets of Sao Paulo visiting with retailer by retailer block by block you will find an excellent point-of-sale coverage of our brands and a very good product acceptance by clients and customers. In few words, somebody else has been eating our cheese, which is the value we can create from our plants to the point-of-sale. This is one of the main competitive advantages of Coca-Cola FEMSA.

In order to counterattack these developments, we are aggressively taking over the traditional channel. During the last three months we have developed 35,000 new points-of-sale, which were attended by indirect channels in the past. They represent almost 50 percent more clients from a base of 75,000 that we had the day we closed the acquisition. Attending these clients directly will result in higher margins for KOF and a better control of the market. We have aligned the price and architecture of our approach by channel in order to reduce the intermediation margin that eventually is used against us in the marketplace through depressed prices. Weighted average prices were increased by approximately 30 percent during March of 2003, including an increase in brands Tai and Simba (ph) of approximately 40 percent. These specific initiatives will reduce volumes significantly until the month of April. We had been reversing these volume trends to recover in May, achieving positive operating income in June for the first time in the last ten month. We have been also in conversation with the Coca-Cola Company and the rest the Coca-Cola bottlers in Brazil to strengthen coordination mechanisms to eliminate transshipment and to develop a diverse portfolio of packaging presentations that we expect to launch during the second half of 2003. The integration process in Brazil has advanced faster than expected. Our people are highly focused on marketplace execution with excellence and on developing and retaining new clients. Today high morale driven by the desire to be part of our winning team is the spirit that you will feel and sense in our Brazilian operations.

In Venezuela the success of our multi-segmentation strategy and returnable packaging focus is helping us increase service volume by 16.4 percent during the second quarter, mainly driven by incremental volumes coming from core brands in returnable presentations. Brand Coca-Cola was the main driver of volume growth, generating more than 70 percent of the incremental volume during the quarter. The 1.25 liter returnable glass presentation reached more than 20 percent of our total sales volume in the second quarter of 2003. At the same time, our channel segmentation strategy is helping us increase volumes of our premium brands. Brand Coca-Cola Light and the recent introduction of FEMSA Light reinforced the leadership that Coca-Cola FEMSA has on the premium segments, addressing a specific needs of customers willing to pay a higher price for this product. Our returnable presentations provide a clear competitive advantage versus our non-branded competitors. Our experience in returnable approach in Mexico and Argentina provide us with a meaningful experience that we expect to extrapolate in our new territories. Now, let me talk about the important developments regarding the financial position of the Company. On June 18 of this year, our company raised 5,750,000,000 Mexican pesos through a three bond offering in the Mexican debt capital markets, equivalent to approximately $550 million. This bonds offerings are the largest one ever made by a non-government entity in Mexico and was issued at a lower rate than our previous bond offering that took in place in April of this year. With this transaction 50 percent of our total debt is denominated in local currency. We have been able to raise close to $1 billion of Mexican peso denominated bonds during the last three months. This clearly highlights the strong credit profile of our Company and the support of our creditors and bondholders.

The maturity profile of our debt provides us with sufficient flexibility to concentrate on running our operations and to use financial instruments to reach the appropriate financial structure. As a result of the (inaudible) position, following the Mexican GAAP guidelines, we recognize as intangible assets with indefinite life the difference between the price paid and book value of net assets acquired. To identify intangibles in Panamco our worth is slightly more than $3 billion, which are mainly the bottling contract with the Coca-Cola Company. We will annually review the carrying value of our intangible and long lived assets for recoverability. We also will review for impairment whenever events or changes in circumstances indicate that the current amount of an asset may not be recoverable. If they are impaired, we are required to recognize a loss by writing off part of part of their value. The analysis that we perform require that we estimate the future cash flows attributable to these assets, and these estimates require us to make a variety of judgments about our future operations, including without limitation volume, prices, cost, inflation, exchange rates and interest rates. The value of the intangible assets also considers the restructuring charges that we expect to take as we streamline our operations within the next year. As a result, we do not expect to take write-offs within the next year.

I have no doubt that we will be able to create significant value over time. We are progressing better than planned. We're finding more opportunities than expected. And the new management that we have in our new territories have strengthened our pool of talent. We cannot thank enough our shareholders, bondholders and creditors for their trust, patience and support. We feel confident about the potential of our management to increase the profitability of our business. We intend to implement a focused and more sustainable value creation equation of volume and price for each country. We will continue sharing with use the progress of our business plan and new initiatives. Thank you for your attention. Now, operator, I would like to open up the call for any questions.

(CALLER INSTRUCTIONS) Mike Braca (ph) with Lehman Brothers. Please go ahead.

Hector, I wanted to touch base on your information systems, and specifically the timing of the rollout of SAP to replace the Coke Basis system. Is it your plan to have SAP implemented throughout Mexico by year end 2003? And what is the timing for rolling out SAP across all of your market territories?

Good morning, Mike. Right now what has happened is that we have started a pilot in two warehouses in Mexico with this new business industry solution on SAP. And the plans that we have called for this year and the rest of 2004 to fully develop the (inaudible) system in Mexico, including the new territories. The idea that we have is that in the other territories -- the new territories that we acquired and rest of -- other than Mexico, in the old Panamco, they also have SAP, but they have a different configuration for some of these different areas. So, as a first stage in those areas, we are working parallel just to try to integrate to the same SAP platform in all the models financial and accounting and production planning, maintenance and all of that. And the second stage to allow this industry business industry solution.

On that second stage, the online market info, should we expect that to really -- the step function improvement being the small format stores where you'll see the biggest improvement as opposed the large format stores?

Yes, Mike. The main issue that we have with the old Basis is that it is very difficult to have different prices for the same SKU as you go to different customers. And that is in characteristic that we're looking in this new solution that we are piloting in the warehouses in Mexico. But the answer is correct. For us, it is more useful on the larger portion of our clients, which is the mom-and-pops.

Lore Serra of Morgan Stanley. Please go ahead.

I have a couple of questions. Let me start with sort of the big picture ones. Hector, when you made the original announcement of the Panamco acquisition you talked about 120 million of synergies and coming through in a period of two years. As you sort of had, as you say, about 100 days in the operations, can you talk about how those benchmarks have changed, if at all?

Lore, the main areas where we have -- find opportunities is obviously as we close the Miami office and the majority of Mexico (inaudible) is where we have found immediately some savings. As we mentioned, we have closed four plants and fifteen distribution centers. And we can say that, basically, we are with the same idea of around $120 million. And we're probably slightly faster paced than we were anticipating. We have also managed to restructure some of the contract that we have with unions in Mexico that Panamco used to have in Mexico. That will create some improvements on the distribution costs. Before, let me just open up here a little bit of explanation. Before basically 100 percent of the compensation of the sales force in the old Gulfo and Bajia rations were viable and, therefore, was very difficult to improve on that cost because it didn't matter if you have half of the people, as the compensation was based on that a per case basis, you would end up paying basically the same. Now we have changed that to a more -- the system that Coca-Cola FEMSA has. Still we have a very large viable compensation, but it is based on targets as opposed to the number of cases. So in general, our feeling is that still the $120 million amount is the right amount. And the difference is that we are moving at a faster pace than when we were anticipating.

Great. And just a couple of specific questions on Mexico in the quarter. The 8.2 percent growth that you mentioned in the press release, is that including the Ciel 5 liter jug or not?

Yes, that includes the Ciel 5 liter. And that comprises excluding the Kin Light Powder Pro that we had last year.

And then just two follow questions then. It seems like there wasn't much volume growth in non-Mexico City portion. And I wonder if you comment on whether that was the transition or what? And then second issue is, as best as I can tell, and obviously I'm comparing apples to oranges because the first quarter only had Coke FEMSA, the second quarter has both. But it looks like your pricing per case declined about 2.5 percent. And I wonder if you could comment on whether you attribute that entirely to the 2.5 liter, or if there's been any other activity going on there?

Yes. In general the price effect that we have has to do basically with the 2.5-liter, with the upside that we have there, and also with the fact that we're now selling water in 5 liter presentation at an equivalent per unit case much lower than Ciel. That is the main effect on the prices. And in general, you're right; in general, you see that the value of Mexico was the one that have the largest volume increase. And I would will say the very general of the same level the Southeast and the Gulf region. And then the Bajio was slightly negative when we compare versus what Panamco was achieving last year.

Can you just give us a rough sense of what the 2.5 liter was as a percent of your mix in the quarter?

Okay, one second. Lore, I have the information with me for the Valley of Mexico, which is basically where we have it, and it was representing around 20 percent of the mix.

Thank you very much.

Actually less than 20 percent. It was 19 and a fraction.

Carlos Laboy of Bear Stearns. Please go ahead.

Hector, I was hoping you could give us -- shed some more light on Brazil. How do you look at pricing going forward in Brazil? Do you expect to take more pricing throughout the course of the year? In the area of third-party distribution, how far are you from having the third-party distribution structure that you want to have in Brazil? Are you mostly done with taking on third parties? And as far as packaging in Brazil, are you likely to introduce returnable packages, and what sizes, and in what timeframe?

Good morning, Carlos. Prices. Some of the first movements that we did was to reduce slightly the prices of Tia and Zima as they were suffering a lot -- as mentioned, they were -- April volumes were a lot depressed. And we believe that those two presentations were serving the role as value protection brands. However, we're certainly looking at what can we do in terms of new presentations and what can that -- those new presentations can bring for us in terms of pricing. Right now it is too early to start discussing, especially for competitive considerations, where exactly our plans in that respect. But we do plan to launch new presentations and SKUs in (inaudible).

With respect to the distribution, part of this -- what we have done is that -- and let me qualify a little bit what I was saying with Tia and Zima, what I was referring there is the price to the consumer. With respect to the price that we receive, which is related to the price we sell to our clients, we have been able to increase that for our Company, as we have tried to reduce the intermediation process of some of these wholesalers. In other words, we have increased prices to these wholesalers so that they -- as a way of trying to reduce the penetration of the presence of these guys, some of them have been taken out of business because they went bankrupt, and we have taken the distribution directly. And in some cases we have just decided to go and take the distribution directly with the suffering and pain that that carries, as we're trying to go directly to the market. As I mentioned during this conference, during the first 100 days that we have been operating there, we have started to serve directly 35,000 clients that were selling Coca-Cola but were not attended by our delivery trucks. They were served by wholesalers or third parties. So a lot of the effort you'll see in Brazil going forward is to try to regain and take control of the direct distribution efforts. That might imply that at some point in time we see decreasing volumes as we have seen. Because obviously, it takes time and understanding and knowledge of the clients to start going to them directly. But we believe that is the right movement -- that the movement is in the right direction.

Hector, in terms of where you are with taking over the third-party distributors, is there a lot more work ahead?

Yes, Carlos, we are just starting with that. We basically have one major third-party that we so far have terminated the agreement. But we still need to work a lot on that. And very importantly, it is very -- the real challenge is if we can also get the other bottlers to start working in more coordination as we go to market and, therefore, avoid this (inaudible) that has been pressuring Brazil for a long time.

Is there a future for returnable bottles in your territories?

Yes. Definitely, we see a future for returnable bottles.

Marco Vera of Deutsche IXE. Please go ahead.

Regarding the (inaudible) soft drinks model, Panamco was reportedly exploring a much tighter model with Heineken, especially after Panama. I'm interested in finding out how you are giving continuity to such projects, if indeed you are? And also interested in all the other markets and whether this would be another part of the overhaul program in the rest of the territories the you how own?

Hi, Marco. Good morning. Well, as you correctly pointed out Panamco was working in Panama very closely with (inaudible). Once the acquisition was completed of the beer business by Heineken and the Costa Rica Brewery, and Panamco acquiring the soft drink portion of this. We still have some shared warehouse space and some back office functions that are still shared. The idea that we have and we are working on separating these functions so we have a very clear understanding of what is Heineken's business in Panama and what is our business in Panama. But at the same token, we're maintaining conversations to explore what is reasonable to have together in terms of distribution of warehouse space or management or sales efforts or promotional activities. But as a first stage, we have bettered our target of fully separating the businesses, understanding what is exactly us and what is exactly Heineken's. In Sao Paulo we're working with Molson, with Kaiser brand trying to understand the relationship better and working closer together. And the other phenomena that we have seen is that as Ambit (ph) is going into Guatemala, we have seen a lot of, I guess, activity as basically approaches from the Central America Brewers to explore possibilities of doing something together with the Coca-Cola bottler in those regions that happened to be Coca-Cola(inaudible). So we have seen a lot of activity in that (inaudible) market. The brewers of the different countries, especially in Guatemala, calling to explore if there's a possibility to do some kind of joint efforts in the regions as we're seeing and there is (inaudible) in this region. But that is basically what we have seen and what it respects to soft drinks and beer doing some kind of business together.

I would have thought that maybe the more that was probably at the forefront of your priorities would have been Argentina, but maybe that was a mistake versus a mistake in perception.

We have -- even before the acquisition we have explored the possibility of -- now that you mention (inaudible) working together in that market. We had been able, and we have seen that our strategic movements in Argentina with respect to returnable presentations and what we have done in there market there has been very successful. So we have not been so interactive moving in that direction. We have explored some possibilities with some of the local brewers. And we have you know reviewed this information that is available, or that was available when (inaudible) was selling these operations in Argentina. I don't know if there is a process -- a legal process in place that has stopped this auction process for some brands and production assets in Argentina, but it is something that for us should be important to analyze this. We are with an open mind just looking at what the opportunity for us would be on that front.

Sure. Hector, just one last question on Mexico. On the introductory price in Mexico for the 2.5, can you update us on your views regarding the ability and timing you envision to move from the current level, given the current pricing strategies of PBG?

Yes. What we have seen, Marco, and way we approach this, remember we launched the 2.5 at the same price as the 2-liter with the idea that that will give us some space to move the prices a little bit in the future. At the same time, we were looking at basically the Mexico City area as the only market where we would want to develop this presentation. And then what has happened is that we're seeing the benefits and the merits of this presentation in urban centers. So we are, as we mentioned, we're moving to Puebla, to (inaudible) and some of the Bajio regions. And we see the price movement still a possibility, but a little but father down the road.

Your next questions comes from Robert Ford of Merrill Lynch. Marco Vera:

Just to continue on that theme of the 2.5-liter refillable presentation, Hector. Can you discuss specifically how effective that has been in terms of the value proposition versus B brands in the territories where you have it and where you don't have it?

Good morning, Bob. The analogy that we have performed in the marketplace indicates basically that where we have the 2.5 returnable (inaudible) we have found that the competitors that have lower price, or B brands, that they have a very hard time performing in the market. You are specifically speaking about (inaudible). What you have seen is that in the mom-and-pop store where we have a very strong presence of this 2.5 liter returnable presentation, in the mom-and-pops they are having a very hard time moving them. So they are now doing some inroads in supermarkets and getting to the very large-scale like the (inaudible) and things like that. And that obviously allows the supermarkets they don't carry 2.5 returnable presentation, in and that we have to compete with some other some other SKUs? But again in the majority of our retail outlets, which are these (inaudible) mom-and-pop, we do see a very important role for the 2.5-liter presentation. In some of the areas where we have introduced in Puebla, which is like the second effort that we have, we have started to do some things and, as I mentioned (inaudible), we serve Coca-Cola (inaudible) territories. But in Puebla, that was very hard hit by (inaudible). Even the fact that the production plant is near Puebla, we have seen important increases in volume in brand Coca-Cola through this introduction. We basically have seen or experienced close to a 6 percent improvement in physical cases. In other words, we are not only changing one 2-liter bottle, but if it was one 2.5 returnable bottle, it is a bit more than that. It is a 6 percent increase on physical cases. It is very hard to measure that, exactly what the impact of that is because, obviously, you have some kind of evaluation on your own (inaudible) liter presentation. So it is not a full direct effect, but it is certainly a very important element in our competition equation versus the low-priced guys.

And with respect to Venezuela, I thought that the improvement in profitability there was remarkable. Can you talk a little bit about some of the pricing changes that you made subsequently to your architectural, maybe in more detailed terms -- some detailed terms of the changes in fixed cost and operating practices. And then lastly what the market share dynamics have been with respect to Pepsi and to be brand competitors there?

Yes. In Venezuela obviously one of the main issues that we were confronted with was this issue of availability of raw materials, because a lot of our suppliers were either pricing in dollars, or in some cases when it was a total local raw material, they were pricing in dollars (inaudible) and they were trying to keep like that. So a lot of the efforts have been directed towards finding and renegotiating the supply contracts so that we have a total local currency payables. We have had a very hard time, although it is improving slightly the flow of dollars for PET, which is basically the only raw material that remains in dollars. We have seen some flow of dollars of these control dollars from this agency that is called (inaudible) that sells the control dollars. So we have had some success lately, but it was very hard in the beginning to start getting some of these resources. I think that the fact that some of the new brands, especially the Cola Real in Venezuela is 100 percent a one-way presentations, has also created this problem for them as raw materials have increasingly significantly in costs. So what we have seen there is a very strong decrease in the market presence in Cola Real. Some indications signal that they are close to between 50-60 percent of the market penetration that they used to have at year end.

So as we were going through these times we decided to focus our (inaudible) into brand Coca-Cola, so that brand Coca-Cola would not suffer from any shortfall in raw materials and all of that. And that is why you have seen a lot of improvements in brand Coca-Cola, even though at the end of the day volumes were slightly negative. But brand Coca-Cola was growing double-digit. And the idea that we have is to continue working on some of the efficiencies in production and distribution. As we mentioned, we have closed a couple of plants there. We're looking at returnable packages as an alternative. We do believe that the economic situations we have in Venezuela, which is what is happening in Argentina also with this crisis, we should have a good penetration of returnables. Coca-Cola FEMSA has the largest penetration of returnables in the country from all of our competitors. So we should take advantage of that and start re-launching some of the old presentations and maybe some new presentations. And again, you have to be very careful with the control of your costs. And that is something that we think we have done in this last quarter, and that has helped us to be positive in the operating results. One of our concerns is that now, obviously, is that we're generating bolivers and there is not a clear picture as to how are we going to dividend up or dividend up bolivers or dollars to Coca-Cola FEMSA, or pay down some of the debt that we have in Venezuela, because the exchange controls that we have still do not allow the Company to -- doesn't allow the Company to buy dollars to either pay dividends or pay down debt. So that is some of the issues that we have going forward there. In other words, we're generating bolivers. We are positive in our results. That is the good news. The bad news is that those resources so far have to stay there. And obviously, we're confident at that some point in the future we will find a way to start benefiting from that.

Sure. Hector, one last question. That was with respect to the tax rate. I wanted to get some clarification there. It looks as if you paid no cash taxes, yet you had a net cash credit, and the remainder of your tax bill is entirely deferred. Is that correct? And then I wanted to see what the longer-term outlook in terms of the effective rate and the split between actual cash payments and deferred taxes would be like?

Well, we were paying -- we have been paying taxes. What you have there in the financial statements is that as we have important expenses related to the acquisition of Panamco, namely season expense related to all the credits and the bank facilities, season expenses related to lawyers and M&A advisers for both Panamco and Coca-Cola FEMSA, all of those expenses were capitalized as part of the acquisition costs for financial purposes. But for tax purposes we're able to deduct part -- excuse me, deduct that as part of the expenses for the quarter. That is why this quarter looks a bit weird in that respect. Also, all this severance that we have paid with respect to some of the closedowns and in plants and distribution centers, as well as the corporate expenses, are also part of the acquisition costs of Panamco from a financial reporting point of view. But for tax purposes, we're deducting that as an expense of the period. So it is -- if you want we can review later on a little bit what the tax -- the cash tax processes for the Company. This is basically what I see more as an onetime saving on the, let me call it, nominal tax rate that we have on our financial statements.

Our next question is from Pablo Zuanic of J.P. Morgan. Please go ahead.

A couple of questions. First of all, in Mexico when we talk about pricing in the Panamco territories, can you give us a sense of where are those prices really to Mexico City? Because here you are implementing that scaling there, but in the case of Mexico City you were able to fund that with the 600ml price increase and other increases. Give us a sense of what you think you can be able to increase in those territories, or is it just going to be a matter of one product being -- the price being cut down by about 25 percent in this case?

Yes, Pablo. Good morning. I would say -- let me try to explain the two or three most important things that we have done with respect to prices in the Panamco territories. One is that -- let me start with the easiest to explain. On jug water, we felt that when we did the analysis of the profitability ratio of that presentation we found that the profitability was very, very small and in some cases, even negative. So we decided that if we want to be in that business, we should rebase that -- or set a new volume standard for that, but start from that volume with a profitable proposition for us. So we decided to increase basically what it turned out to be around a 25 percent increase on jug water.

And with that movement we believe now that, although volumes are not growing, or in some cases declining, that we have a good profit operation for the Company. The other one is -- has to do with the 2 liter presentation that they had in some areas. As we're planning to launch the 2.5 liter presentation, and they were selling in some areas 2-liter at 10 pesos, we decided to increase that in some cases to 11, or in some cases to 12. So that when we have the introduction of the 2.5 in the future we will also go with that new presentation of 12 pesos as a way of, let me put it, paving the way for the introduction of the 2.5. So that is another movement that we have done with respect to prices in the Gulf and Bajio region. And clearly, the other movement that we will have is that we're definitely thinking of launching this 2.5 presentation, returnable presentation, in some of the areas where -- some of the urban areas, some of the large cities that we have in these territories. Those are basically, I would say, the three movements that we are thinking of on the old Panamco territories.

On the other four (inaudible), Hector, for example, on 600ml would you see opportunities in that sense, or in other formants also in soft drinks?

Yes, we definitely have found some opportunities which are basically counted on a case-by-case basis and on specific areas or cities. In some cases we have increased prices of the small former presentations, yes.

Just a follow-up question, Hector, then. Big Cola recently announced that they're going to be launching a 2.6 liter grapefruit presentation, and apparently other flavors may follow down the road. Does that mean that Coca-Cola FEMSA will also implement that scaling strategy on flavors? And if so, how would you do it if you don't sell a 2 liter returnable now for flavors?

Yes. We have seen in Puebla a grapefruit product with the name Prisco. And they're selling also at 9 pesos, 2.6 liters. What we're thinking so far is that in some of the flavor presentations where we should be doing this upside into 2.5-liter on one way. We don't think that right now we should move to returnable presentations on flavors. Again, it is the whole strategy of the brand equity that Coca-Cola -- the brand Coca-Cola has. Clearly, (inaudible) a lot of the -- give us the reasoning why we can launch a returnable presentation on those cases with brand Coca-Cola. The grapefruit segments there they are attending is not that large, and we need to start seeing how things evolve before we decide to move into returnable presentations. Right now, we will stay with 2-liters and if needed move to 2.5. And then if it merits because of the circumstances to move to returnables, we might move to returnable in one or two flavors, not in the whole range of flavors that we have.

Right. Thank you. Now just a question on the CAPEX front. Year-to-date for the six months sites, Coca-Cola FEMSA CAPEX $80 million. Guidance is still I understand 350, FEMSA 28 -- 1.1, almost $1 billion. Can you give us more color in terms of what the CAPEX is for? Is it to buy distributors in Brazil? Is it to buy -- to build a mega plant in Mexico, or do you want to now bring that CAPEX guidance down?

Let me tell you, since the very beginning beginning -- since the very beginning, meaning in December when we announced the acquisition, we were saying that we had around $650 million for the first full year of operation of CAPEX. We believe that the number might be slightly lower, probably around the $300 million level for this year. But let me explain. The majority of this CAPEX is in Mexico. One of the things that we have found is that a lot of the distribution costs that Panamco had was very old (inaudible) there were not in optimal conditions, meaning that the maintenance costs was very large. So we have started to upgrade that immediately. We have acquired already 200 trucks, which is a big portion of the float that Panamco has. Those trucks are going to be rolled out during this year. We have already put the order for that. We've also invested in coolers, and very importantly, on the bottles and cases for the 2.5 liter returnable presentations in Puebla and some of the other cities. That carries a lot of the bargain for CAPEX on Mexico, which is the majority of the CAPEX that we have, on this 300 million number that I gave you. There's a lot of maintenance or expenditures that are related to maintenance or improvements in some of the production plants. But the main -- the bulk of the investments are trucks, coolers, bottles and cases and systems as it relates to the transformation to our -- or the upgrade to our SAP platform.

So these are mainly one off CAPEX? That doesn't mean that the '04 number should be significantly lower?

Yes. I think that in general, Pablo, I think that somewhere around 4-6 percent of revenues is a good number as CAPEX for bottling in this industry to move.

Okay, that's good. Just a follow up on Venezuela, if I may, Hector. Did Pepsi-Cola actually follow the price increase in February?

Let me check on that. I'm not sure. I think they also moved to it, but I need to check on that. Pablo, I will have to get back to you with that because I don't have the information right now with me. Alfredo will give you call on (multiple speakers).

That's fine. Just one last question, Hector. With this tweaking of prices for the water jugs in the Panamco territories, if that works out does that mean that you will consider launching jugs in Mexico City? Twenty liter jugs I mean?

Yes. I'm not sure -- I think that -- I mean if it works the answer is yes. Although we have to understand that for us, we had been out of that market. We have a very successful presentation with the 5 liter one-way returnable package. A lot of the effort that we do on the old Panamco territories are related to home delivery with a system that is specialized for that. And Mexico City has some very different characteristics with respect to traffic and all of that. So I will not rule it out, but it is not in our near term programs.

(CALLER INSTRUCTIONS) Our next question come from Alex Robarts of Santander. Please go ahead.

I wanted to get into more of the Mexico volume growth numbers here for a little bit. This 8 percent growth in the Valley of Mexico, can you give us a sense, Hector, how much of that was really organic versus market share gain? I'm assuming that there were some gains against DVG (ph). Were there some gains against also the Cola? Give us a sense perhaps of what the industry was doing for CSDs also in Valley of Mexico? And where you know kind of in the last six months have -- or can we kind of characterize the penetration of Cola Real in terms of market share? If you can give us the comment there, that would be great?

Yes. I think, Alex, that in general what you have seen as you have the new presentations and new competitors coming into the city with large formats at very attractive prices. What you have seen is a growth in the industry, especially with respect to the Cola segments. In general, while I don't have the exact information with me, but in general the trends that we have seen is that you have seen both (inaudible) U.S. and Pepsi-Cola lost -- we have seen (inaudible) and Coca-Cola lose some share against Cola Real as Cola Real has gone into the supermarket channels. So they have captured some points in that specific channel that has translated into some market share gains. I think that again what has happened is the industry has increased in size because of this competitors coming and both Coca-Cola FEMSA and Pepsi-Cola having more attractive propositions to consumers as it relates to the 2.5-liter returnable presentation. But in the total equation we have seen some market share erosion on both Pepsi-Cola and Coca-Cola.

And the industry growth roughly in the Valley of Mexico, if you had to give a ballpark?

Let me ask Alfredo to follow with that because I don't have the industry information with me right now.

Okay. But clearly there were some gains against -- did you have gains against Pepsi in your view? Or is that -- should we do this off-line perhaps?

No. I'm a little bit hesitant because obviously to answer this because obviously it is different as it relates to brand Coca-Cola versus Pepsi-Cola and when you compare some flavors. There a lot of different activities going on in the market. But in general, I think that both companies have lost a little share. And Pepsi-Cola has lost a little bit more of share in this battle. So that probably implies that we gained a bit versus Pepsi-Cola.

Okay.

Let me get some more hard data from Nielsen, and Alfredo will call you with that.

Sure. The big Cola penetration was roughly, I guess you were saying 1 percent or 2 percent of your points-of-sale. Is that still kind of the level that we're seeing, or is it a little bit more than that?

Yes, I think that somewhere around one-third point is what we have seen in general in Mexico City. In some other areas we have gained share against Cola Real, especially in the old Panamco regions where they had a higher penetration. As I mentioned, for example in Venezuela, their share when to basically half of what they have. But in the Mexico -- speaking of our Mexico as a country, in Mexico City we have lost a little bit of share. We have lost a little bit in the Southeast. But we have gained in some of the old Panamco territories.

Well, that was a follow-up. Just kind of understanding here in terms of the Panamco territories as you look out for the next balance of the year. Clearly Q2 there are probably some transitions issues in the Mexico Panamco territories. Is this Puebla upscale and maybe some of the other cities; is that going to be something that you expect to get the non-Mexico City Mexican volume up and kind of in positive territory? Is this really going to be the driver here for the balance of the year, or the think that getting and reaching the kind of growth that you are seeing in the Valley of Mexico, Hector, is something more like a longer-term goal?

No, definitely we have a lot of expectation for the 2.5-liter presentation in returnable plastic on these territories. This is not a single (inaudible) obviously we have to look at different packages and flavors. And it is a very dynamic process in terms of new introductions, Alex. But definitely 2.5, it is a very important element of our strategy going forward in the urban centers.

Okay. Just the last one is more of an accounting question here on the intangibles. I see that you have put it on the balance sheet, obviously. And I guess it is safe to assume that there will be no amortization expense here going forward from the goodwill. But I was just curious, what was the counter account here that you did on the balance sheet? You put it obviously in the assets, but did it go against the shareholders equity? In other words, would that shareholders equity, now post-acquisition, would it higher? Or maybe you could just kind of talk a little bit about that?

Yes. What we did, Alex, is that first of all we went through the process of defining or determining the fair value of the assets. For that we hired two independent firms to go and do the analysis in all the different countries. With that analysis we also did some adjustments for some of the plants that we have in terms of closedowns, severance, expenses related to the financing and the acquisition, as I mentioned, with respect to M&A and lawyer fees and all of that. And with all of that we defined the base of the reported -- the equity value that we were acquiring, excluding goodwill that Panamco has. In other words, all the goodwill that Panamco has was erased. And then from that net equity value we compare versus the price that we were paying. And that difference we have to test for -- as we're going to do every year -- for impairment.

In other words, we have to say this is the value of the goodwill or the intangible in this case that we have. Do we have future cash flows that justify this value? We went through the analysis together with Deloitte and Touche, the people that specialize in intangible valuation. Any answer is, yes, we do have cash flow to justify this value, and that is why all of these amounts were registered as intangibles. Now the intangible assets that we have, the main value is assigned to the contract that we have with Coca-Cola. Panamco has some proprietary brands. There is some value assigned to that as they have some brands in different territories. And there was a small amount assigned to non-compete agreements that we have either from employees of Panamco that were terminated and signed some non-compete agreements, and also from some of the agreements that they have with beer operations in Central America. So that is basically the general-purpose -- the general process. So that you define the value of the assets. Some of the expenses that you have, you reduce the equity of what you were acquiring. And then the difference between that equity and the purchase price is what you are assigning to -- that we are assigning to the intangibles in this initial balance sheet. And we have to test for impairment every year. Or if there is you know a devaluation of a currency or whatever, we have to test for that also in intermediate periods. But going forward, the new accounting -- the Mexican accounting rules we will not have any amortization of that intangible going forward on that yearly basis. Just to expand a little bit more on that, when you define this intangible amount, you also have to assign that to the difference countries of the different operations. So in our books we have values assigned to Mexico, to Brazil, to Venezuela, etc. And that is what we are going to test going forward.

Your next question comes from Dan Wilcousky (ph) of Schroders (ph) Please go ahead. .

I've got a few questions. Could you quantify the expected annual synergies from the stats that you have already undertaken the closing in the Mexico City offices and Miami before plant closures and the distribution closures?

Dan, Good morning. Right now, as I mentioned we are still expecting around $120 million in the period of two years. As I mentioned, we're going a little bit faster than that. But so far what we believe we have pretty much in our pockets right now is around $40 million in savings because of the closing of these facilities and the closings of the offices in Miami and Mexico City. So basically we have around $40 million so far already with us.

Can you also tell us what progress you have made in July in terms of closures or restructuring?

Some of the closings that we announced actually happened in July, so basically what we have is the latest update.

Okay. And to me at least, the Central America numbers in terms of the margins look quite low. Panamco never disclosed what the numbers were anyway. Has anything significantly changed since you took control of the Central America operations? Has their margins always been this low?

We basically have -- I think that you have two effects here. One is the inclusion of Panama that was previously noted (inaudible) had a lower margin than some of the other operations. And really when you come to review this, it is Panama with a lot of opportunities, a lot of expenses that you can clear. Guatemala with a very complicated labor situation that has basically negligible profitability. And the rest of the countries are pretty much more or less in good shape. Not at the level of profitability that we have in some of our other territories in Mexico, and therefore with opportunities for us. But main change that we have is the inclusion of Panama into these numbers.

And over the longer term, over the next two to three years, what sort of margin do you think is achievable in Central America, the 20's?

I think that you can get into those levels and actually some of countries are around that level. The issue is basically Guatemala and bringing Panama into better operation. We did have some impact of exchange rate movements. And obviously again in general in other countries we had effect of very expensive PET costs, but that is equal on all the territories that we have. That is why we're going through the war in Iraq. Oil prices went up significantly and PET costs increased importantly. In dollar terms, indications where you have some movement on the exchange rate, that effect was compounded.

Mr. Trevino, at this time there are no further questions in the queue.

Well, thank you very much for your attention. I know that this has been a very complicated quarter because we are only presenting two months of Panamco. We're working to be able to obviously -- give us a lot of information, or more information as we advance in this integration process so that you have a clearer picture of how things are advancing. Thank you for your attention.

Ladies and gentlemen, thank you for your participation in today's call. You may disconnect now.