UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

 

Form 10-K

 

 

Commission file number 001-33829

 

(Exact name of Registrant as specified in its charter)

 

 

5301 Legacy Drive,

Plano, Texas 75024

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code:

(972) 673-7000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes o     No þ

 

The aggregate market value of the common equity held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and Directors are “affiliates” of the registrant) as of June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was $5,382,637,224 (based on closing sale price of registrant’s Common Stock on that date as reported on the New York Stock Exchange).

 

As of February 19, 2010, there were 254,115,758 shares of the registrant’s common stock, par value $0.01 per share, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Proxy Statement to be filed with the Securities and Exchange Commission in connection with the registrant’s Annual Meeting of Stockholders to be held on May 20, 2010, are incorporated by reference in Part III.

 

 

DR PEPPER SNAPPLE GROUP, INC.

 

FORM 10-K
For the Year Ended December 31, 2009

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements including, in particular, statements about future events, future financial performance, plans, strategies, expectations, prospects, competitive environment, regulation and availability of raw materials. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “intend” or the negative of these terms or similar expressions in this Annual Report on Form 10-K. We have based these forward-looking statements on our current views with respect to future events and financial performance. Our actual financial performance could differ materially from those projected in the forward-looking statements due to the inherent uncertainty of estimates, forecasts and projections, and our financial performance may be better or worse than anticipated. Given these uncertainties, you should not put undue reliance on any forward-looking statements.

 

Forward-looking statements represent our estimates and assumptions only as of the date that they were made. We do not undertake any duty to update the forward-looking statements, and the estimates and assumptions associated with them, after the date of this Annual Report on Form 10-K, except to the extent required by applicable securities laws. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed in Item 1A under “Risks Related to Our Business” and elsewhere in this Annual Report on Form 10-K. These risk factors may not be exhaustive as we operate in a continually changing business environment with new risks emerging from time to time that we are unable to predict or that we currently do not expect to have a material adverse effect on our business. You should carefully read this report in its entirety as it contains important information about our business and the risks we face.

 

Our forward-looking statements are subject to risks and uncertainties, including:

 

 

 

Our Company

 

Dr Pepper Snapple Group, Inc. is a leading integrated brand owner, manufacturer and distributor of non-alcoholic beverages in the United States, Canada and Mexico with a diverse portfolio of flavored (non-cola) carbonated soft drinks (“CSDs”) and non-carbonated beverages (“NCBs”), including ready-to-drink teas, juices, juice drinks and mixers. We have some of the most recognized beverage brands in North America, with significant consumer awareness levels and long histories that evoke strong emotional connections with consumers. References in this Annual Report on Form 10-K to “we”, “our”, “us”, “DPS” or “the Company” refer to Dr Pepper Snapple Group, Inc. and its subsidiaries, unless the context requires otherwise.

 

The following table provides highlights about our company:

 

 

History of Our Business

 

We have built our business over the last three decades through a series of strategic acquisitions. In the 1980’s through the mid-1990’s, we began building on our then existing Schweppes business by adding brands such as Mott’s, Canada Dry and A&W and a license for Sunkist soda. We also acquired the Peñafiel business in Mexico. In 1995, we acquired Dr Pepper/Seven Up, Inc., having previously made minority investments in the company. In 1999, we acquired a 40% interest in Dr Pepper/Seven Up Bottling Group, Inc., (“DPSUBG”), which was then our largest independent bottler, and increased our interest to 45% in 2005. In 2000, we acquired Snapple and other brands, significantly increasing our share of the United States NCB market segment. In 2003, we created Cadbury Schweppes Americas Beverages by integrating the way we managed our four North American businesses (Mott’s, Snapple, Dr Pepper/Seven Up and Mexico). During 2006 and 2007, we acquired the remaining 55% of DPSUBG and several smaller bottlers and integrated them into our Packaged Beverages segment, thereby expanding our geographic coverage.

 

Separation from Cadbury and Formation of Our Company

 

In 2008, Cadbury Schweppes plc (“Cadbury Schweppes”) separated its beverage business in the United States, Canada, Mexico and the Caribbean (the “Americas Beverages business”) from its global confectionery business by contributing the subsidiaries that operated its Americas Beverages business to us. The separation involved a number of steps, and as a result of these steps:

 

 

We were incorporated in Delaware on October 24, 2007. Prior to separation, Dr Pepper Snapple Group, Inc. did not have any operations. Refer to Note 3 of the Notes to our Audited Consolidated Financial Statements for further information.

 

Products and Distribution

 

We are a leading integrated brand owner, manufacturer and distributor of non-alcoholic beverages in the United States, Mexico and Canada and we also distribute our products in the Caribbean. In 2009, 90% of our net sales were generated in the United States, 4% in Canada and 6% in Mexico and the Caribbean. We sold 1.6 billion equivalent 288 fluid ounce cases in 2009. The following table provides highlights about our key brands:

 

CSDs

 

 

Our Core 4 brands

 

 

Other CSD brands

 

 

NCBs

 

 

The market and industry data in this Annual Report on Form 10-K is from independent industry sources, including The Nielsen Company and Beverage Digest. See “Market and Industry Data” below for further information.

 

The Sunkist soda, Rose’s and Margaritaville logos are registered trademarks of Sunkist Growers, Inc., Cadbury Ireland Limited and Margaritaville Enterprises, LLC, respectively, in each case used by us under license. All other logos in the table above are registered trademarks of DPS or its subsidiaries.

 

In the CSD market in the United States and Canada, we participate primarily in the flavored CSD category. Our key brands are Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry and Crush, and we also sell regional and smaller niche brands. In the CSD market we are primarily a manufacturer of beverage concentrates and fountain syrups. Beverage concentrates are highly concentrated proprietary flavors used to make syrup or finished beverages. We manufacture beverage concentrates that are used by our own Packaged Beverages and Latin America Beverages segments, as well as sold to third party bottling companies. According to The Nielsen Company, we had a 21.0% share of the United States CSD market in 2009 (measured by retail sales), which increased from 19.7% in 2008. We also manufacture fountain syrup that we sell to the foodservice industry directly, through bottlers or through third parties.

 

In the NCB market segment in the United States, we participate primarily in the ready-to-drink tea, juice, juice drinks and mixer categories. Our key NCB brands are Snapple, Mott’s, Hawaiian Punch and Clamato, and we also sell regional and smaller niche brands. We manufacture most of our NCBs as ready-to-drink beverages and distribute them through our own distribution network and through third parties or direct to our customers’ warehouses. In addition to NCB beverages, we also manufacture Mott’s apple sauce as a finished product.

 

In Mexico and the Caribbean, we participate primarily in the carbonated mineral water, flavored CSD, bottled water and vegetable juice categories. Our key brands in Mexico include Peñafiel, Squirt, Clamato and Aguafiel. In Mexico, we manufacture and sell our brands through both our own manufacturing and distribution operations and third party bottlers. In the Caribbean, we distribute our products solely through third party distributors and bottlers.

 

In 2009, we manufactured and/or distributed approximately 44% of our total products sold in the United States (as measured by volume). In addition, our businesses manufacture and distribute a variety of brands owned by third parties in specified licensed geographic territories.

 

Our Strengths

 

The key strengths of our business are:

 

Strong portfolio of leading, consumer-preferred brands.  We own a diverse portfolio of well-known CSD and NCB brands. Many of our brands enjoy high levels of consumer awareness, preference and loyalty rooted in their rich heritage, which drive their market positions. Our diverse portfolio provides our bottlers, distributors and retailers with a wide variety of products and provides us with a platform for growth and profitability. We are the #1 flavored CSD company in the United States. In addition, we are the only major beverage concentrate company with year-over-year market share growth in the CSD market in each of the last five years. Our largest brand, Dr Pepper, is the #2 flavored CSD in the United States, according to The Nielsen Company, and our Snapple brand is a leading ready-to-drink tea. Overall, in 2009, approximately 75% of our volume was generated by brands that hold either the #1 or #2 position in their category. The strength of our key brands has allowed us to launch innovations and brand extensions such as Dr Pepper Cherry, 7UP Cherry Antioxidant, Canada Dry Green Tea Ginger Ale, Mott’s for Tots and Snapple value teas.

 

Integrated business model.  We believe our brand ownership, manufacturing and distribution are more integrated than the United States operations of our principal competitors and that this differentiation provides us with a competitive advantage. Our integrated business model strengthens our route-to-market by creating a third consolidated bottling system in addition to the Coca-Cola Company (“Coca-Cola”) and PepsiCo, Inc. (“PepsiCo”) affiliated systems. Our manufacturing and distribution system enables us to improve focus on our brands, especially certain of our brands such as 7UP, Sunkist soda, A&W and Snapple, which do not have a large presence in the Coca-Cola-affiliated and PepsiCo-affiliated bottler systems. Our integrated business model also provides opportunities for net sales and profit growth through the alignment of the economic interests of our brand ownership and our manufacturing and distribution businesses. For example, we can focus on maximizing profitability for our company as a whole rather than focusing on profitability generated from either the sale of beverage concentrates or the bottling and distribution of our products. Additionally, our integrated business model enables us to be more flexible and responsive to the changing needs of our large retail customers by coordinating sales, service, distribution, promotions and product launches and allows us to more fully leverage our scale and reduce costs by creating greater geographic manufacturing and distribution coverage.

Strong customer relationships.  Our brands have enjoyed long-standing relationships with many of our top customers. We sell our products to a wide range of customers, from bottlers and distributors to national retailers, large foodservice and convenience store customers. We have strong relationships with some of the largest bottlers and distributors, including those affiliated with Coca-Cola and PepsiCo, some of the largest and most important retailers, including Wal-Mart, Safeway, Kroger and Target, some of the largest food service customers, including McDonald’s, Yum! Brands, Jack in the Box and Burger King, and convenience store customers, including 7-Eleven. Our portfolio of strong brands, operational scale and experience across beverage segments has enabled us to maintain strong relationships with our customers.

 

Attractive positioning within a large and profitable market.  We hold the #1 position in the United States flavored CSD beverage markets by volume according to Beverage Digest. We are also a leader in Canada and Mexico beverage markets. We believe that these markets are well-positioned to benefit from emerging consumer trends such as the need for convenience and the demand for products with health and wellness benefits. Our portfolio of products is biased toward flavored CSDs, which continue to gain market share versus cola CSDs, but also focuses on emerging categories such as teas, energy drinks and juices.

 

Broad geographic manufacturing and distribution coverage.  As of December 31, 2009, we had 19 manufacturing facilities and 176 distribution centers in the United States, as well as four manufacturing facilities and 27 distribution centers in Mexico. These facilities use a variety of manufacturing processes. We have strategically located manufacturing and distribution capabilities, enabling us to better align our operations with our customers, reduce transportation costs and have greater control over the timing and coordination of new product launches. In addition, our warehouses are generally located at or near bottling plants and geographically dispersed to ensure our products are available to meet consumer demand. We actively manage transportation of our products using our own fleet of more than 5,000 delivery trucks, as well as third party logistics providers on a selected basis.

 

Strong operating margins and stable cash flows.  The breadth of our brand portfolio has enabled us to generate strong operating margins which have delivered stable cash flows. These cash flows enable us to consider a variety of alternatives, such as investing in our business, reducing our debt, paying dividends to our stockholders and repurchasing shares of our common stock.

 

Experienced executive management team.  Our executive management team has over 200 years of collective experience in the food and beverage industry. The team has broad experience in brand ownership, manufacturing and distribution, and enjoys strong relationships both within the industry and with major customers. In addition, our management team has diverse skills that support our operating strategies, including driving organic growth through targeted and efficient marketing, reducing operating costs, enhancing distribution efficiencies, aligning manufacturing and distribution interests and executing strategic acquisitions.

 

Our Strategy

 

The key elements of our business strategy are to:

 

Build and enhance leading brands.  We have a well-defined portfolio strategy to allocate our marketing and sales resources. We use an on-going process of market and consumer analysis to identify key brands that we believe have the greatest potential for profitable sales growth. We intend to continue to invest most heavily in our key brands to drive profitable and sustainable growth by strengthening consumer awareness, developing innovative products and brand extensions to take advantage of evolving consumer trends, improving distribution and increasing promotional effectiveness.

 

Focus on opportunities in high growth and high margin categories.  We are focused on driving growth in our business in selected profitable and emerging categories. These categories include ready-to-drink teas, energy drinks and other beverages. We also intend to capitalize on opportunities in these categories through brand extensions, new product launches and selective acquisitions of brands and distribution rights. For example, we believe we are well-positioned to enter into new distribution agreements for emerging, high-

growth third party brands in new categories that can use our manufacturing and distribution network. We can provide these new brands with distribution capability and resources to grow, and they provide us with exposure to growing segments of the market with relatively low risk and capital investment.

 

Increase presence in high margin channels and packages.  We are focused on improving our product presence in high margin channels, such as convenience stores, vending machines and small independent retail outlets, through increased selling activity and significant investments in coolers and other cold drink equipment. We have embarked on an expanded placement program for our branded coolers and other cold drink equipment and intend to significantly increase the number of those types of equipment over the next few years, which we believe will provide an attractive return on investment. We also intend to increase demand for high margin products like single-serve packages for many of our key brands through increased promotional activity.

 

Leverage our integrated business model.  We believe our integrated brand ownership, manufacturing and distribution business model provides us opportunities for net sales and profit growth through the alignment of the economic interests of our brand ownership and our manufacturing and distribution businesses. We intend to leverage our integrated business model to reduce costs by creating greater geographic manufacturing and distribution coverage and to be more flexible and responsive to the changing needs of our large retail customers by coordinating sales, service, distribution, promotions and product launches. For example, we intend to concentrate more of our manufacturing in multi-product, regional manufacturing facilities, including opening a new plant in Southern California in 2010 and investing in expanded capabilities in several of our existing facilities within the next several years.

 

Strengthen our route-to-market.  In the near term, strengthening our route-to-market will ensure the ongoing health of our brands. We are rolling out handheld technology and upgrading our information technology (“IT”) infrastructure to improve route productivity and data integrity and standards. With third party bottlers, we continue to deliver programs that maintain priority for our brands in their systems.

 

Improve operating efficiency.  The integration of acquisitions into our Direct Store Delivery system (“DSD”), a component of our Packaged Beverages segment, has created the opportunity to improve our manufacturing, warehousing and distribution operations. For example, we have been able to create multi-product manufacturing facilities (such as our Irving, Texas facility) which provide a region with a wide variety of our products at reduced transportation and co-packing costs. In 2009, we established a Productivity Office to drive ongoing productivity initiatives.

 

Our Business Operations

 

As of December 31, 2009, our operating structure consists of three business segments: Beverage Concentrates, Packaged Beverages and Latin America Beverages. Segment financial data for 2009, 2008 and 2007, including financial information about foreign and domestic operations, is included in Note 21 of the Notes to our Audited Consolidated Financial Statements.

 

Beverage Concentrates

 

Our Beverage Concentrates segment is principally a brand ownership business. In this segment we manufacture and sell beverage concentrates in the United States and Canada. Most of the brands in this segment are CSD brands. In 2009, our Beverage Concentrates segment had net sales of approximately $1.1 billion. Key brands include Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry, Crush, Schweppes, Squirt, RC Cola, Diet Rite, Sundrop, Welch’s, Vernors and Country Time and the concentrate form of Hawaiian Punch.

 

We are the industry leader in flavored CSDs with a 40.3% market share in the United States for 2009, as measured by retail sales according to The Nielsen Company. We are also the third largest CSD brand owner as measured by 2009 retail sales in the United States and Canada and we own a leading brand in most of the CSD categories in which we compete.

 

Almost all of our beverage concentrates are manufactured at our plant in St. Louis, Missouri.

The beverage concentrates are shipped to third party bottlers, as well as to our own manufacturing systems, who combine them with carbonation, water, sweeteners and other ingredients, package it in PET containers, glass bottles and aluminum cans, and sell it as a finished beverage to retailers. Beverage concentrates are also manufactured into syrup, which is shipped to fountain customers, such as fast food restaurants, who mix the syrup with water and carbonation to create a finished beverage at the point of sale to consumers. Dr Pepper represents most of our fountain channel volume. Concentrate prices historically have been reviewed and adjusted at least on an annual basis.

 

Our Beverage Concentrates brands are sold by our bottlers, including our own Packaged Beverages segment, through all major retail channels including supermarkets, fountains, mass merchandisers, club stores, vending machines, convenience stores, gas stations, small groceries, drug chains and dollar stores. Unlike the majority of our other CSD brands, 72% of Dr Pepper volumes are distributed through the Coca-Cola affiliated and PepsiCo affiliated bottler systems.

 

Pepsi Bottling Group, Inc. (“PBG”) and Coca-Cola Enterprises, Inc. (“CCE”) are the two largest customers of the Beverage Concentrates segment, and constituted 25% and 23%, respectively, of net sales during 2009.

 

Packaged Beverages

 

Our Packaged Beverages segment is principally a brand ownership, manufacturing and distribution business. In this segment, we primarily manufacture and distribute packaged beverages and other products, including our brands, third party owned brands and certain private label beverages, in the United States and Canada. In 2009, our Packaged Beverages segment had net sales of approximately $4.1 billion. Key NCB brands in this segment include Snapple, Mott’s, Hawaiian Punch, Clamato, Yoo-Hoo, Country Time, Nantucket Nectars, ReaLemon, Mr and Mrs T, Rose’s and Margaritaville. Key CSD brands in this segment include Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry, Squirt, RC Cola, Welch’s, Vernors, IBC, Mistic and Venom Energy.

 

Approximately 87% of our 2009 Packaged Beverages net sales of branded products come from our own brands, with the remaining from the distribution of third party brands such as FIJI mineral water and AriZona tea. A portion of our sales also comes from bottling beverages and other products for private label owners or others for a fee. Although the majority of our Packaged Beverages’ net sales relate to our brands, we also provide a route-to-market for third party brand owners seeking effective distribution for their new and emerging brands. These brands give us exposure in certain markets to fast growing segments of the beverage industry with minimal capital investment.

 

Our Packaged Beverages’ products are manufactured in multiple facilities across the United States and are sold or distributed to retailers and their warehouses by our own distribution network or by third party distributors. The raw materials used to manufacture our products include aluminum cans and ends, glass bottles, PET bottles and caps, paper products, sweeteners, juices, water and other ingredients.

 

We sell our Packaged Beverages’ products both through our DSD, supported by a fleet of more than 5,000 trucks and approximately 12,000 employees, including sales representatives, merchandisers, drivers and warehouse workers, as well as through our Warehouse Direct delivery system (“WD”), both of which include the sales to all major retail channels, including supermarkets, fountain channel, mass merchandisers, club stores, vending machines, convenience stores, gas stations, small groceries, drug chains and dollar stores.

 

In 2009, Wal-Mart Stores, Inc., the largest customer of our Packaged Beverages segment, accounted for approximately 17% of our net sales in this segment.

 

Latin America Beverages

 

Our Latin America Beverages segment is a brand ownership, manufacturing and distribution business. This segment participates mainly in the carbonated mineral water, flavored CSD, bottled water and vegetable juice categories, with particular strength in carbonated mineral water and grapefruit flavored CSDs. In 2009, our Latin America Beverages segment had net sales of $357 million with our operations in Mexico representing approximately 88% of the net sales of this segment. Key brands include Peñafiel, Squirt, Clamato and Aguafiel.

In Mexico, we manufacture and distribute our products through our bottling operations and third party bottlers and distributors. In the Caribbean, we distribute our products through third party bottlers and distributors. In Mexico, we also participate in a joint venture to manufacture Aguafiel brand water with Acqua Minerale San Benedetto. We provide expertise in the Mexican beverage market and Acqua Minerale San Benedetto provides expertise in water production and new packaging technologies.

 

We sell our finished beverages through all major Mexican retail channels, including the “mom and pop” stores, supermarkets, hypermarkets, and on premise channels.

 

Bottler and Distributor Agreements

 

In the United States and Canada, we generally grant perpetual, exclusive license agreements for CSD brands and packages to bottlers for specific geographic areas. These agreements prohibit bottlers from selling the licensed products outside their exclusive territory and selling any imitative products in that territory. Generally, we may terminate bottling agreements only for cause or change in control and the bottler may terminate without cause upon giving certain specified notice and complying with other applicable conditions. Fountain agreements for bottlers generally are not exclusive for a territory, but do restrict bottlers from carrying imitative product in the territory. Many of our brands such as Snapple, Mistic, Stewart’s, Nantucket Nectars, Yoo-Hoo and Orangina, are licensed for distribution in various territories to bottlers and a number of smaller distributors such as beer wholesalers, wine and spirit distributors, independent distributors and retail brokers. We may terminate some of these distribution agreements only for cause and the distributor may terminate without cause upon certain notice and other conditions. Either party may terminate some of the other distribution agreements without cause upon giving certain specified notice and complying with other applicable conditions.

 

Agreement with PepsiCo, Inc.

 

On December 8, 2009, DPS agreed to license certain brands to PepsiCo, Inc. (“PepsiCo”) on closing of PepsiCo’s proposed acquisitions of PBG and PepsiAmericas, Inc. (“PAS”).

 

Under the new licensing agreements, PepsiCo will distribute Dr Pepper, Crush and Schweppes in the U.S. territories where these brands are currently distributed by PBG and PAS. The same will apply for Dr Pepper, Crush, Schweppes, Vernors and Sussex in Canada; and Squirt and Canada Dry in Mexico.

 

Under the agreements, DPS will receive a one-time cash payment of $900 million. The new agreement will have an initial period of twenty years with automatic twenty year renewal periods, and will require PepsiCo to meet certain performance conditions. The payment will be recorded as deferred revenue, which will be recognized as net sales ratably over the estimated 25-year life of the customer relationship.

 

Additionally, in U.S. territories where it has a distribution footprint, DPS will begin distributing certain owned and licensed brands, including Sunkist soda, Squirt, Vernors, Canada Dry and Hawaiian Punch, that were previously distributed by PBG and PAS.

 

On February 26, 2010, the Company completed the licensing of those brands to PepsiCo following PepsiCo’s acquisition of PBG and PAS.

 

Customers

 

We primarily serve two groups of customers: 1) bottlers and distributors and 2) retailers.

 

Bottlers buy beverage concentrates from us and, in turn, they manufacture, bottle, sell and distribute finished beverages. Bottlers also manufacture and distribute syrup for the fountain foodservice channel. In addition, bottlers and distributors purchase finished beverages from us and sell them to retail and other customers. We have strong relationships with bottlers affiliated with Coca-Cola and PepsiCo primarily because of the strength and market position of our key Dr Pepper brand.

Retailers also buy finished beverages directly from us. Our portfolio of strong brands, operational scale and experience in the beverage industry has enabled us to maintain strong relationships with major retailers in the United States, Canada and Mexico. In 2009, our largest retailer was Wal-Mart Stores, Inc., representing approximately 13% of our net sales.

 

Seasonality

 

The beverage market is subject to some seasonal variations. Our beverage sales are generally higher during the warmer months and also can be influenced by the timing of holidays as well as weather fluctuations.

 

Competition

 

The liquid refreshment beverage industry is highly competitive and continues to evolve in response to changing consumer preferences. Competition is generally based upon brand recognition, taste, quality, price, availability, selection and convenience. We compete with multinational corporations with significant financial resources. Our two largest competitors in the liquid refreshment beverage market are Coca-Cola and PepsiCo, each representing more than 30% of the U.S. liquid refreshment beverage market by volume, according to Beverage Digest. We also compete against other large companies, including Nestlé, S.A. (“Nestle”) and Kraft Foods Inc. (“Kraft”). These competitors can use their resources and scale to rapidly respond to competitive pressures and changes in consumer preferences by introducing new products, reducing prices or increasing promotional activities. As a bottler, we compete with bottlers such as CCE, PBG,PAS and a number of smaller bottlers and distributors. We also compete with a variety of smaller, regional and private label manufacturers, such as The Cott Corporation (“Cott”). Smaller companies may be more innovative, better able to bring new products to market and better able to quickly exploit and serve niche markets. We have lower exposure to some of the faster growing non-carbonated and the bottled water segments in the overall liquid refreshment beverage market and as a result, although we have increased our market share in the overall United States CSD market, we have lost share in the overall United States liquid refreshment beverage market over the past several years. In Canada, Mexico and the Caribbean, we compete with many of these same international companies as well as a number of regional competitors.

 

Although these bottlers and distributors are our competitors, many of these companies are also our customers as they purchase beverage concentrates from us.

 

Intellectual Property and Trademarks

 

Our Intellectual Property.  We possess a variety of intellectual property rights that are important to our business. We rely on a combination of trademarks, copyrights, patents and trade secrets to safeguard our proprietary rights, including our brands and ingredient and production formulas for our products.

 

Our Trademarks.  Our trademark portfolio includes more than 2,500 registrations and applications in the United States, Canada, Mexico and other countries. Brands we own through various subsidiaries in various jurisdictions include Dr Pepper, 7UP, A&W, Canada Dry, RC Cola, Schweppes, Squirt, Crush, Peñafiel, Aguafiel, Snapple, Mott’s, Hawaiian Punch, Clamato, Mistic, Nantucket Nectars, Mr & Mrs T, ReaLemon, Venom and Deja Blue. We own trademark registrations for all of these brands in the United States, and we own trademark registrations for some but not all of these brands in Canada, Mexico and other countries. We also own a number of smaller regional brands. Some of our other trademark registrations are in countries where we do not currently have any significant level of business. In addition, in many countries outside the United States, Canada and Mexico, our rights to many of our brands, including our Dr Pepper trademark and formula, were sold by Cadbury beginning over a decade ago to third parties including, in certain cases, to competitors such as Coca-Cola.

 

Trademarks Licensed from Others.  We license various trademarks from third parties, which generally allow us to manufacture and distribute throughout the United States and/or Canada and Mexico. For example, we license from third parties the Sunkist soda, Welch’s, Country Time, Orangina, Stewart’s, Rose’s, Holland House and Margaritaville trademarks. Although these licenses vary in length and other terms, they generally are long-term, cover the entire United States and/or Canada and Mexico and generally include a royalty payment to the licensor.

Licensed Distribution Rights.  We have rights in certain territories to bottle and/or distribute various brands we do not own, such as AriZona tea and FIJI mineral water. Some of these arrangements are relatively shorter in term, are limited in geographic scope and the licensor may be able to terminate the agreement upon an agreed period of notice, in some cases without payment to us.

 

Intellectual Property We License to Others.  We license some of our intellectual property, including trademarks, to others. For example, we license the Dr Pepper trademark to certain companies for use in connection with food, confectionery and other products. We also license certain brands, such as Dr Pepper and Snapple, to third parties for use in beverages in certain countries where we own the brand but do not otherwise operate our business.

 

Marketing

 

Our marketing strategy is to grow our brands through continuously providing new solutions to meet consumers’ changing preferences and needs. We identify these preferences and needs and develop innovative solutions to address the opportunities. Solutions include new and reformulated products, improved packaging design, pricing and enhanced availability. We use advertising, media, sponsorships, merchandising, public relations and promotion to provide maximum impact for our brands and messages.

 

Manufacturing

 

As of December 31, 2009, we operated 23 manufacturing facilities across the United States and Mexico. Almost all of our CSD beverage concentrates are manufactured at a single plant in St. Louis, Missouri. All of our manufacturing facilities are either regional manufacturing facilities, with the capacity and capabilities to manufacture many brands and packages, facilities with particular capabilities that are dedicated to certain brands or products, or smaller bottling plants with a more limited range of packaging capabilities. We will open a new, multi-product manufacturing facility in Southern California during 2010.

 

We employ approximately 5,000 full-time manufacturing employees in our facilities, including seasonal workers. We have a variety of production capabilities, including hot-fill, cold-fill and aseptic bottling processes, and we manufacture beverages in a variety of packaging materials, including aluminum, glass and PET cans and bottles and a variety of package formats, including single-serve and multi-serve packages and “bag-in-box” fountain syrup packaging.

 

In 2009, 89% of our manufactured volumes came from our brands and 11% from third party and private-label products. We also use third party manufacturers to package our products for us on a limited basis.

 

We owned property, plant and equipment, net of accumulated depreciation, totaling $1,044 million and $935 million in the United States and $65 million and $55 million in international locations as of December 31, 2009 and 2008, respectively.

 

Warehousing and Distribution

 

As of December 31, 2009, our distribution network consisted of 176 distribution centers in the United States and 27 distribution centers in Mexico. Our warehouses are generally located at or near bottling plants and are geographically dispersed to ensure product is available to meet consumer demand. We actively manage transportation of our products using combination of our own fleet of more than 5,000 delivery trucks, as well as third party logistics providers.

 

Raw Materials

 

The principal raw materials we use in our business are aluminum cans and ends, glass bottles, PET bottles and caps, paper products, sweeteners, juice, fruit, water and other ingredients. The cost of the raw materials can fluctuate substantially. In addition, we are significantly impacted by changes in fuel costs due to the large truck fleet we operate in our distribution businesses.

Under many of our supply arrangements for these raw materials, the price we pay fluctuates along with certain changes in underlying commodities costs, such as aluminum in the case of cans, natural gas in the case of glass bottles, resin in the case of PET bottles and caps, corn in the case of sweeteners and pulp in the case of paperboard packaging. Manufacturing costs for our Packaged Beverages segment, where we manufacture and bottle finished beverages, are higher as a percentage of our net sales than our Beverage Concentrates segment as the Packaged Beverages segment requires the purchase of a much larger portion of the packaging and ingredients. Although we have contracts with a relatively small number of suppliers, we have generally not experienced any difficulties in obtaining the required amount of raw materials.

 

When appropriate, we mitigate the exposure to volatility in the prices of certain commodities used in our production process through the use of futures contracts and supplier pricing agreements. The intent of the contracts and agreements is to provide predictability in our operating margins and our overall cost structure.

 

Research and Development

 

Our research and development team is composed of scientists and engineers in the United States and Mexico who are focused on developing high quality products which have broad consumer appeal, can be sold at competitive prices and can be safely and consistently produced across a diverse manufacturing network. Our research and development team engages in activities relating to product development, microbiology, analytical chemistry, process engineering, sensory science, nutrition, knowledge management and regulatory compliance. We have particular expertise in flavors and sweeteners. Research and development costs are expensed when incurred and amounted to $15 million and $17 million for 2009 and 2008, respectively. Research and development costs totaled $14 million for 2007, net of allocations to Cadbury. Additionally, we incurred packaging engineering costs of $7 million, $4 million, and $5 million for 2009, 2008 and 2007, respectively. These expenses are recorded in selling, general and administrative expenses in our Consolidated Statements of Operations.

 

Information Technology and Transaction Processing Services

 

We use a variety of IT systems and networks configured to meet our business needs. Prior to our separation from Cadbury, IT support was provided as a corporate service by Cadbury’s IT team and external suppliers. Post separation, we have formed our own standalone, dedicated IT function to support our business and have separated our systems, services and contracts from those of Cadbury. Our primary IT data center is hosted in Toronto, Canada by a third party provider. We also use a third party vendor for application support and maintenance, which is based in India and provides resources offshore and onshore.

 

We use a business process outsourcing provider located in India to provide certain back office transactional processing services, including accounting, order entry and other transactional services.

 

Employees

 

At December 31, 2009, we employed approximately 19,000 employees, including seasonal and part-time workers.

 

In the United States, we have approximately 16,000 full-time employees. We have many union collective bargaining agreements covering approximately 4,000 full-time employees. Several agreements cover multiple locations. These agreements often address working conditions as well as wage rates and benefits. In Mexico and the Caribbean, we employ approximately 3,000 full-time employees and are also party to collective bargaining agreements. We do not have a significant number of employees in Canada.

 

We believe we have good relations with our employees.

 

Regulatory Matters

 

We are subject to a variety of federal, state and local laws and regulations in the countries in which we do business. Regulations apply to many aspects of our business including our products and their ingredients, manufacturing, safety, labeling, transportation, recycling, advertising and sale. For example, our products, and their manufacturing, labeling, marketing and sale in the United States are subject to various aspects of the Federal

Food, Drug, and Cosmetic Act, the Federal Trade Commission Act, the Lanham Act, state consumer protection laws and state warning and labeling laws. In Canada and Mexico, the manufacture, distribution, marketing and sale of our many products are also subject to similar statutes and regulations.

 

We and our bottlers use various refillable and non-refillable, recyclable bottles and cans in the United States and other countries. Various states and other authorities require deposits, eco-taxes or fees on certain containers. Similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. In Mexico, the government has encouraged the soft drinks industry to comply voluntarily with collection and recycling programs of plastic material, and we have taken steps to comply with these programs.

 

Environmental, Health and Safety Matters

 

In the normal course of our business, we are subject to a variety of federal, state and local environment, health and safety laws and regulations. We maintain environmental, health and safety policies and a quality, environmental, health and safety program designed to ensure compliance with applicable laws and regulations. The cost of such compliance measures does not have a material financial impact on our operations.

 

Available Information

 

Our web site address is www.drpeppersnapplegroup.com. Information on our web site is not incorporated by reference in this document. We make available, free of charge through this web site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission.

 

Market and Industry Data

 

The market and industry data in this Annual Report on Form 10-K is from independent industry sources, including The Nielsen Company and Beverage Digest. Although we believe that these independent sources are reliable, we have not verified the accuracy or completeness of this data or any assumptions underlying such data.

 

The Nielsen Company is a marketing information provider, primarily serving consumer packaged goods manufacturers and retailers. We use The Nielsen Company data as our primary management tool to track market performance because it has broad and deep data coverage, is based on consumer transactions at retailers, and is reported to us monthly. The Nielsen Company data provides measurement and analysis of marketplace trends such as market share, retail pricing, promotional activity and distribution across various channels, retailers and geographies. Measured categories provided to us by The Nielsen Company Scantrack include flavored (non-cola) CSDs, energy drinks, single-serve bottled water, non-alcoholic mixers and NCBs, including ready-to-drink teas, single-serve and multi-serve juice and juice drinks, and sports drinks. The Nielsen Company also provides data on other food items such as apple sauce. The Nielsen Company data we present in this report is from The Nielsen Company’s Scantrack service, which compiles data based on scanner transactions in certain sales channels, including grocery stores, mass merchandisers, drug chains, convenience stores and gas stations. However, this data does not include the fountain or vending channels, Wal-Mart or small independent retail outlets, which together represent a meaningful portion of the United States liquid refreshment beverage market and of our net sales and volume.

 

Beverage Digest is an independent beverage research company that publishes an annual Beverage Digest Fact Book. We use Beverage Digest primarily to track market share information and broad beverage and channel trends. This annual publication provides a compilation of data supplied by beverage companies. Beverage Digest covers the following categories: CSDs, energy drinks, bottled water and NCBs (including ready-to-drink teas, juice and juice drinks and sports drinks). Beverage Digest data does not include multi-serve juice products or bottled water in packages of 1.5 liters or more. Data is reported for certain sales channels, including grocery stores, mass merchandisers, club stores, drug chains, convenience stores, gas stations, fountains, vending machines and the “up-and-down-the-street” channel consisting of small independent retail outlets.

We use both The Nielsen Company and Beverage Digest to assess both our own and our competitors’ performance and market share in the United States. Different market share rankings can result for a specific beverage category depending on whether data from The Nielsen Company or Beverage Digest is used, in part because of the differences in the sales channels reported by each source. For example, because the fountain channel (where we have a relatively small business except for Dr Pepper) is not included in The Nielsen Company data, our market share using The Nielsen Company data is generally higher for our CSD portfolio than the Beverage Digest data, which does include the fountain channel.

 

In this Annual Report on Form 10-K, all information regarding the beverage market in the United States is from Beverage Digest, and, except as otherwise indicated, is from 2008. All information regarding our brand market positions in the U.S. is from The Nielsen Company and is based on retail dollar sales in 2009.

 

 

Risks Related to Our Business

 

In addition to the other information set forth in this report, you should carefully consider the risks described below which could materially affect our business, financial condition, or future results. Any of the following risks, as well as other risks and uncertainties, could harm our business and financial condition.

 

We operate in highly competitive markets.

 

The liquid refreshment beverage industry is highly competitive and continues to evolve in response to changing consumer preferences. Competition is generally based upon brand recognition, taste, quality, price, availability, selection and convenience. We compete with multinational corporations with significant financial resources. Our two largest competitors in the liquid refreshment beverage market are Coca-Cola and PepsiCo, each representing more than 30% of the U.S. liquid refreshment beverage market by volume, according to Beverage Digest. We also compete against other large companies, including Nestle and Kraft. These competitors can use their resources and scale to rapidly respond to competitive pressures and changes in consumer preferences by introducing new products, reducing prices or increasing promotional activities. As a bottler, we compete with bottlers such as CCE, PBG, PAS and a number of smaller bottlers and distributors. We also compete with a variety of smaller, regional and private label manufacturers, such as Cott. Smaller companies may be more innovative, better able to bring new products to market and better able to quickly exploit and serve niche markets. We have lower exposure to some of the faster growing non-carbonated and the bottled water segments in the overall liquid refreshment beverage market and as a result, although we have increased our market share in the overall United States CSD market, we have lost share in the overall United States liquid refreshment beverage market over the past several years. In Canada, Mexico and the Caribbean, we compete with many of these same international companies as well as a number of regional competitors.

 

Although these bottlers and distributors are our competitors, many of these companies are also our customers as they purchase beverage concentrates from us.

 

Our inability to compete effectively could result in a decline in our sales. As a result, we may have to reduce our prices or increase our spending on marketing, advertising and product innovation. Any of these could negatively affect our business and financial performance.

 

We may not effectively respond to changing consumer preferences, trends, health concerns and other factors.

 

Consumers’ preferences can change due to a variety of factors, including aging of the population, social trends, negative publicity, economic downturn or other factors. For example, consumers are increasingly concerned about health and wellness, and demand for regular CSDs has decreased as consumers have shifted towards low or no calorie soft drinks and, increasingly, to NCBs, such as water, ready-to-drink teas and sports drinks. If we do not effectively anticipate these trends and changing consumer preferences, then quickly develop new products in

response, our sales could suffer. Developing and launching new products can be risky and expensive. We may not be successful in responding to changing markets and consumer preferences, and some of our competitors may be better able to respond to these changes, either of which could negatively affect our business and financial performance.

 

We depend on a small number of large retailers for a significant portion of our sales.

 

Food and beverage retailers in the United States have been consolidating, resulting in large, sophisticated retailers with increased buying power. They are in a better position to resist our price increases and demand lower prices. They also have leverage to require us to provide larger, more tailored promotional and product delivery programs. If we and our bottlers and distributors do not successfully provide appropriate marketing, product, packaging, pricing and service to these retailers, our product availability, sales and margins could suffer. Certain retailers make up a significant percentage of our products’ retail volume, including volume sold by our bottlers and distributors. Some retailers also offer their own private label products that compete with some of our brands. The loss of sales of any of our products in a major retailer could have a material adverse effect on our business and financial performance.

 

We depend on third party bottling and distribution companies for a portion of our business.

 

Net sales from our Beverage Concentrates segment represent sales of beverage concentrates to third party bottling companies that we do not own. The Beverage Concentrates segment’s net sales generate a portion of our overall net sales. Some of these bottlers are partly owned by a competitor. In the case of PBG and PAS, PepsiCo has acquired majority ownership. Additionally, Coca-Cola is now in the process of acquiring ownership of CCE’s North American bottling business. The majority of these bottlers’ business comes from selling our competitors’ products. In addition, some of the products we manufacture are distributed by third parties. As independent companies, these bottlers and distributors make their own business decisions. They may have the right to determine whether, and to what extent, they produce and distribute our products, our competitors’ products and their own products. They may devote more resources to other products or take other actions detrimental to our brands. In most cases, they are able to terminate their bottling and distribution arrangements with us without cause. We may need to increase support for our brands in their territories and may not be able to pass on price increases to them. Their financial condition could also be adversely affected by conditions beyond our control and our business could suffer. Deteriorating economic conditions could negatively impact the financial viability of third party bottlers. Any of these factors could negatively affect our business and financial performance.

 

Our financial results may be negatively impacted by recession, financial and credit market disruptions and other economic conditions.

 

Customer and consumer demand for our products may be impacted by recession or other economic downturn in the United States, Canada, Mexico or the Caribbean, which could result in a reduction in our sales volume and/or switching to lower price offerings. Similarly, disruptions in financial and credit markets may impact our ability to manage normal commercial relationships with our customers, suppliers and creditors. These disruptions could have a negative impact on the ability of our customers to timely pay their obligations to us, thus reducing our cash flow, or our vendors to timely supply materials.

 

We could also face increased counterparty risk for our cash investments and our hedge arrangements. Declines in the securities and credit markets could also affect our pension fund, which in turn could increase funding requirements.

 

Determinations in the future that a significant impairment of the value of our goodwill and other indefinite lived intangible assets has occurred could have a material adverse effect on our results of operations.

 

As of December 31, 2009, we had $8.8 billion of total assets, of which approximately $5.7 billion were intangible assets. Intangible assets include goodwill, and other intangible assets in connection with brands, bottler agreements, distribution rights and customer relationships. We conduct impairment tests on goodwill and all indefinite lived intangible assets annually, as of December 31, or more frequently if circumstances indicate that the carrying amount of an asset may not be recoverable. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. There was no impairment required based

upon our annual impairment analysis performed as of December 31, 2009. For additional information about these intangible assets, see “Critical Accounting Estimates — Goodwill and Other Indefinite Lived Intangible Assets” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our Audited Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K.

 

The impairment tests require us to make an estimate of the fair value of intangible assets. Since a number of factors may influence determinations of fair value of intangible assets, we are unable to predict whether impairments of goodwill or other indefinite lived intangibles will occur in the future. Any such impairment would result in us recognizing a non-cash charge in our Statement of Operations, which may adversely affect our results of operations.

 

We have a substantial amount of outstanding debt, which could adversely affect our business and our ability to meet our obligations.

 

As of December 31, 2009, our total indebtedness was $2,971 million. Total indebtedness is defined as long-term obligations of $2,960 million, plus the $8 million adjustment related to the change in the fair value of interest rate swaps designated as fair value hedges and the $3 million of current obligations related to capital leases included as a component of accounts payable and accrued expenses. Subsequent to December 31, 2009, the Company made optional repayments of $405 million, which represented the outstanding principal balance on the revolving credit facility (the “Revolver”) as of December 31, 2009.

 

This substantial amount of debt could have important consequences to us and our investors, including:

 

 

To the extent we experience deteriorating economic conditions, the risks described above would increase. Additionally, it may become more difficult to satisfy debt service and other obligations, the cash flow available to fund capital expenditures, other corporate purposes and to grow our business could be reduced. Our actual cash requirements in the future may be greater than expected. Our cash flow from operations may not be sufficient to repay at maturity all of the outstanding debt as it becomes due.

 

In addition, the credit agreements governing our debt contain covenants that, among other things, limit our ability to incur debt at subsidiaries that are not guarantors, incur liens, merge or sell, transfer or otherwise dispose of all or substantially all of our assets, make investments, loans, advances, guarantees and acquisitions, enter into transactions with affiliates and enter into agreements restricting our ability to incur liens or the ability of our subsidiaries to make distributions. The credit agreement also requires us to comply with certain affirmative and financial covenants.

 

We may not comply with applicable government laws and regulations and they could change.

 

We are subject to a variety of federal, state and local laws and regulations in the United States, Canada, Mexico and other countries in which we do business. These laws and regulations apply to many aspects of our business including the manufacture, safety, labeling, transportation, advertising and sale of our products. See “Regulatory Matters” in Item 1, “Business,” of this Annual Report on Form 10-K for more information regarding many of these laws and regulations. Violations of these laws or regulations could damage our reputation and/or result in regulatory actions with substantial penalties. In addition, any significant change in such laws or regulations or their interpretation, or the introduction of higher standards or more stringent laws or regulations could result in increased compliance costs or capital expenditures. For example, changes in recycling and bottle deposit laws or special taxes on soft drinks or ingredients could increase our costs. Regulatory focus on the health, safety and marketing of food products is increasing. Certain state warning and labeling laws, such as California’s “Prop 65,” which requires warnings on any product with substances that the state lists as potentially causing cancer or birth defects, could become applicable to our products.

Some local and regional governments and school boards have enacted, or have proposed to enact, regulations restricting the sale of certain types of soft drinks in schools. Any violations or changes of regulations could have a material adverse effect on our profitability, or disrupt the production or distribution of our products, and negatively affect our business and financial performance. In addition, taxes imposed on the sale of certain of our products by federal, state, local and foreign governments could cause consumers to shift away from purchasing our products. For example, some members of the United States federal government have raised the possibility of a federal tax on the sale of certain “sugared” beverages, including non-diet soft drinks, fruit drinks, teas, and flavored waters, to help pay for the cost of healthcare reform. Some United States state governments are also considering similar taxes. If enacted, such taxes could materially affect our business and financial results.

 

Our distribution agreements with our allied brands could be terminated.

 

Hansen Natural Corporation and glacéau terminated their distribution agreements with us in 2008 and 2007, respectively. We are subject to a risk of other allied brands, such as FIJI and AriZona, terminating their distribution agreements with us, which could negatively affect our business and financial performance.

 

Litigation or legal proceedings could expose us to significant liabilities and damage our reputation.

 

We are party to various litigation claims and legal proceedings. We evaluate these claims and proceedings to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses. We may establish a reserve as appropriate based upon assessments and estimates in accordance with our accounting policies. We base our assessments, estimates and disclosures on the information available to us at the time and rely on legal and management judgment. Actual outcomes or losses may differ materially from assessments and estimates. Actual settlements, judgments or resolutions of these claims or proceedings may negatively affect our business and financial performance. For more information, see Note 20 of the Notes to our Audited Consolidated Financial Statements.

 

Benefits cost increases could reduce our profitability.

 

Our profitability is substantially affected by the costs of pension, postretirement, employee medical costs and other benefits. In recent years, these costs have increased significantly due to factors such as increases in health care costs, declines in investment returns on pension assets and changes in discount rates used to calculate pension and related liabilities. Although we actively seek to control increases in costs, there can be no assurance that we will succeed in limiting future cost increases, and continued upward pressure in costs could have a material adverse affect on our business and financial performance.

 

Costs for our raw materials may increase substantially.

 

The principal raw materials we use in our business are aluminum cans and ends, glass bottles, PET bottles and caps, paperboard packaging, sweeteners, juice, fruit, water and other ingredients. Additionally, conversion of raw materials into our products for sale also uses electricity and natural gas. The cost of the raw materials can fluctuate substantially. We are significantly impacted by increases in fuel costs due to the large truck fleet we operate in our distribution businesses and our use of third party carriers. Under many of our supply arrangements, the price we pay for raw materials fluctuates along with certain changes in underlying commodities costs, such as aluminum in the case of cans, natural gas in the case of glass bottles, resin in the case of PET bottles and caps, corn in the case of sweeteners and pulp in the case of paperboard packaging. Continued price increases could exert pressure on our costs and we may not be able to pass along any such increases to our customers or consumers, which could negatively affect our business and financial performance.

 

Certain raw materials we use are available from a limited number of suppliers and shortages could occur.

 

Some raw materials we use, such as aluminum cans and ends, glass bottles, PET bottles, sweeteners and other ingredients, are sourced from industries characterized by a limited supply base. If our suppliers are unable or unwilling to meet our requirements, we could suffer shortages or substantial cost increases. Changing suppliers can

require long lead times. The failure of our suppliers to meet our needs could occur for many reasons, including fires, natural disasters, weather, manufacturing problems, disease, crop failure, strikes, transportation interruption, government regulation, political instability and terrorism. A failure of supply could also occur due to suppliers’ financial difficulties, including bankruptcy. Some of these risks may be more acute where the supplier or its plant is located in riskier or less-developed countries or regions. Any significant interruption to supply or cost increase could substantially harm our business and financial performance.

 

Substantial disruption to production at our manufacturing and distribution facilities could occur.

 

A disruption in production at our beverage concentrates manufacturing facility, which manufactures almost all of our concentrates, could have a material adverse effect on our business. In addition, a disruption could occur at any of our other facilities or those of our suppliers, bottlers or distributors. The disruption could occur for many reasons, including fire, natural disasters, weather, water scarcity, manufacturing problems, disease, strikes, transportation interruption, government regulation or terrorism. Alternative facilities with sufficient capacity or capabilities may not be available, may cost substantially more or may take a significant time to start production, each of which could negatively affect our business and financial performance.

 

Our facilities and operations may require substantial investment and upgrading.

 

We have an ongoing program of investment and upgrading in our manufacturing, distribution and other facilities. We expect to incur substantial costs to upgrade or keep up-to-date various facilities and equipment or restructure our operations, including closing existing facilities or opening new ones. If our investment and restructuring costs are higher than anticipated or our business does not develop as anticipated to appropriately utilize new or upgraded facilities, our costs and financial performance could be negatively affected.

 

We may not be able to renew collective bargaining agreements on satisfactory terms, or we could experience strikes.

 

As of December 31, 2009, approximately 4,000 of our employees, many of whom are at our key manufacturing locations, were covered by collective bargaining agreements. These agreements typically expire every three to four years at various dates. We may not be able to renew our collective bargaining agreements on satisfactory terms or at all. This could result in strikes or work stoppages, which could impair our ability to manufacture and distribute our products and result in a substantial loss of sales. The terms of existing or renewed agreements could also significantly increase our costs or negatively affect our ability to increase operational efficiency.

 

Our products may not meet health and safety standards or could become contaminated.

 

We have adopted various quality, environmental, health and safety standards. However, our products may still not meet these standards or could otherwise become contaminated. A failure to meet these standards or contamination could occur in our operations or those of our bottlers, distributors or suppliers. This could result in expensive production interruptions, recalls and liability claims. Moreover, negative publicity could be generated from false, unfounded or nominal liability claims or limited recalls. Any of these failures or occurrences could negatively affect our business and financial performance.

 

Our intellectual property rights could be infringed or we could infringe the intellectual property rights of others and adverse events regarding licensed intellectual property, including termination of distribution rights, could harm our business.

 

We possess intellectual property that is important to our business. This intellectual property includes ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets. See “Intellectual Property and Trademarks” in Item 1, “Business,” of this Annual Report on Form 10-K for more information. We and third parties, including competitors, could come into conflict over intellectual property rights. Litigation could disrupt our business, divert management attention and cost a substantial amount to protect our rights or defend

ourselves against claims. We cannot be certain that the steps we take to protect our rights will be sufficient or that others will not infringe or misappropriate our rights. If we are unable to protect our intellectual property rights, our brands, products and business could be harmed.

 

We also license various trademarks from third parties and license our trademarks to third parties. In some countries, other companies own a particular trademark which we own in the United States, Canada or Mexico. For example, the Dr Pepper trademark and formula is owned by Coca-Cola in certain other countries. Adverse events affecting those third parties or their products could affect our use of the trademark and negatively impact our brands.

 

In some cases, we license products from third parties which we distribute. The licensor may be able to terminate the license arrangement upon an agreed period of notice, in some cases without payment to us of any termination fee. The termination of any material license arrangement could adversely affect our business and financial performance.

 

We could lose key personnel or may be unable to recruit qualified personnel.

 

Our performance significantly depends upon the continued contributions of our executive officers and key employees, both individually and as a group, and our ability to retain and motivate them. Our officers and key personnel have many years of experience with us and in our industry and it may be difficult to replace them. If we lose key personnel or are unable to recruit qualified personnel, our operations and ability to manage our business may be adversely affected. We do not have “key person” life insurance for any of our executive officers or key employees.

 

We depend on key information systems and third party service providers.

 

We depend on key information systems to accurately and efficiently transact our business, provide information to management and prepare financial reports. We rely on third party providers for a number of key information systems and business processing services, including hosting our primary data center and processing various accounting, order entry and other transactional services. These systems and services are vulnerable to interruptions or other failures resulting from, among other things, natural disasters, terrorist attacks, software, equipment or telecommunications failures, processing errors, computer viruses, hackers, other security issues or supplier defaults. Security, backup and disaster recovery measures may not be adequate or implemented properly to avoid such disruptions or failures. Any disruption or failure of these systems or services could cause substantial errors, processing inefficiencies, security breaches, inability to use the systems or process transactions, loss of customers or other business disruptions, all of which could negatively affect our business and financial performance.

 

Weather and climate changes could adversely affect our business.

 

Unseasonable or unusual weather or long-term climate changes may negatively impact the price or availability of raw materials, energy and fuel, and demand for our products. Unusually cool weather during the summer months may result in reduced demand for our products and have a negative effect on our business and financial performance.

 

There is growing political and scientific sentiment that increased concentrations of carbon dioxide and other greenhouse gases in the atmosphere are influencing global weather patterns (“global warming”). Changing weather patterns, along with the increased frequency or duration of extreme weather conditions, could negatively impact the availability or increase the cost of key raw materials that we use to produce our products. Additionally, the sale of our products can be negatively impacted by weather conditions.

 

Concern over climate change, including global warming, has led to legislative and regulatory initiatives directed at limiting greenhouse gas (GHG) emissions. For example, proposals that would impose mandatory requirements on GHG emissions continue to be considered by policy makers in the countries that we operate. Laws enacted that directly or indirectly affect our production, distribution, packaging, cost of raw materials, fuel, ingredients, and water could all negatively impact our business and financial results.

 

None.

 

 

United States.  As of December 31, 2009, we owned or leased 209 administrative, manufacturing, and distribution facilities across the United States. Our principal offices are located in Plano, Texas, in a facility that we own. We also lease an office in Rye Brook, New York. Our Packaged Beverages segment owns 13 manufacturing facilities, 56 distribution centers and warehouses, and three office buildings, including our headquarters. They also lease six manufacturing facilities, 120 distribution centers and warehouses, and 10 office buildings.

 

Mexico and Canada.  As of December 31, 2009, we leased four office facilities throughout Mexico and Canada, including our Latin America Beverages operating segment’s principal offices in Mexico City. We own four manufacturing facilities, including one joint venture manufacturing facility, and we have 27 additional direct distribution centers, four of which are owned and 23 of which are leased, in Mexico which are all included in our Latin America Beverages operating segment. Our manufacturing facilities in the United States supply our products to bottlers, retailers and distributors in Canada.

 

We believe our facilities in the United States and Mexico are well-maintained and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based on seasonal demand of our products. It is not possible to measure with any degree of certainty or uniformity the productive capacity and extent of utilization of these facilities. We periodically review our space requirements, and we believe we will be able to acquire new space and facilities as and when needed on reasonable terms. We also look to consolidate and dispose or sublet facilities we no longer need, as and when appropriate.

 

New Facilities.  We are near completion of a new manufacturing and distribution facility in Victorville, California, that will operate as our western hub in a regional manufacturing and distribution footprint serving consumers in California and parts of the desert Southwest. When open in 2010, the facility will produce a wide range of soft drinks, juices, juice drinks, bottled water, ready-to-drink teas, energy drinks and other premium beverages at the Victorville plant. The plant will consist of an 850,000-square-foot building on 57 acres, including 550,000 square feet of warehouse space, and a 300,000-square-foot manufacturing plant. As of December 31, 2009, we had capital commitments of approximately $6 million related to this facility.

 

 

We are occasionally subject to litigation or other legal proceedings relating to our business. See Note 20 of the Notes to our Audited Consolidated Financial Statements for more information related to commitments and contingencies, which are incorporated herein by reference.

 

 

There were no matters submitted to a vote of stockholders during the fourth quarter of 2009.

 

 

In the United States, our common stock is listed and traded on the New York Stock Exchange under the symbol “DPS”. Information as to the high and low sales prices of our stock for the two years ended December 31, 2009, and the frequency and amount of dividends declared on our stock during these periods, is set forth in Note 25 of the Notes to our Audited Consolidated Financials Statements.

As of February 19, 2010, there were approximately 30,000 stockholders of record of our common stock. This figure does not include a substantially greater number of “street name” holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers, and other financial institutions.

 

The information under the principal heading “Equity Compensation Plan Information” in our definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 20, 2010, to be filed with the Securities and Exchange Commission, is incorporated herein by reference.

 

During the fiscal years ended December 31, 2009 and 2008, we did not sell any equity securities that were not registered under the Securities Act of 1933, as amended.

 

Dividend Policy

 

During the fourth quarter of the year ended December 31, 2009 we declared a cash dividend of $.15 per share, which was paid on January 8, 2010. Prior to that declaration, we had not paid a cash dividend on our common stock since our demerger on May 7, 2008. In February, 2010, our board has declared a cash dividend of $.15 per share to be payable on April 8, 2010 to stockholders of record on March 22, 2010.

 

Even though we have recently declared two separate cash dividends, our Board of Directors (the “Board”) has not adopted a formal dividend policy under which we might pay regular periodic dividends to our stockholders. Nonetheless, we expect to return our excess cash flow to our stockholders, from time to time through our common stock repurchase program described below or the payment of dividends. However, there can be no assurance that share repurchases will occur or future dividends will be declared or paid. The share repurchase programs and declaration and payment of future dividends, the amount of any such share repurchases or dividends, and the establishment of record and payment dates for dividends, if any, is subject to final determination by our Board after its review of the then current strategy and financial performance and position, among other things.

 

Common Stock Repurchases

 

On November 20, 2009, the Board authorized the repurchase of up to $200 million of the Company’s outstanding common stock over the next three years.

 

Subsequent to the Board’s authorization, we did not repurchase any of our own common stock during the remainder of 2009.

 

Subsequent to December 31, 2009, the Board authorized the repurchase of an additional $800 million of the Company’s outstanding common stock, for a total of $1 billion authorized.

 

Comparison of Total Stockholder Return

 

The following performance graph compares our cumulative total returns with the cumulative total returns of the Standard & Poor’s 500 and a peer group index. The graph assumes that $100 was invested on May 7, 2008, the day we became a publicly traded company on the New York Stock Exchange, with dividends reinvested.

Comparison of Total Returns
Assumes Initial Investment of $100
December 2009

 

 

 

The Peer Group Index consists of the following companies: The Coca-Cola Company, Coca-Cola Enterprises, Inc, Pepsi Bottling Group, Inc, PepsiAmericas, Inc, PepsiCo, Inc, Hansen Natural Corporation, The Cott Corporation and National Beverage Corporation. We believe that these companies help to convey an accurate comparison of our performance with the industry.

 

The following table presents selected historical financial data as of December 31, 2009, 2008, 2007, 2006 and January 1, 2006 (the last day of fiscal 2005). All the selected historical financial data has been derived from our Audited Consolidated Financial Statements and is stated in millions of dollars except for per share information.

 

For periods prior to May 7, 2008, our financial data have been prepared on a “carve-out” basis from Cadbury’s consolidated financial statements using the historical results of operations, assets and liabilities attributable to Cadbury’s Americas Beverages business and including allocations of expenses from Cadbury. The historical Cadbury’s Americas Beverages information is our predecessor financial information. The results included below and elsewhere in this document are not necessarily indicative of our future performance and do not reflect our financial performance had we been an independent, publicly-traded company during the periods prior to May 7, 2008. You should read this information along with the information included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our Audited Consolidated Financial Statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K.

 

We made three bottler acquisitions in 2006 and one bottler acquisition in 2007. Each of these four acquisitions is included in our consolidated financial statements beginning on its date of acquisition. As a result, our financial data is not comparable on a period-to-period basis.

 

 

 

 

You should read the following discussion in conjunction with our audited financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of various factors including the factors we describe under “Special Note Regarding Forward-Looking Statements”, “Risk Factors,” and elsewhere in this Annual Report on Form 10-K.

 

References in this Annual Report on Form 10-K to “we”, “our”, “us”, “DPS” or “the Company” refer to Dr Pepper Snapple Group, Inc. and all entities included in our Audited Consolidated Financial Statements. Cadbury plc and Cadbury Schweppes plc are hereafter collectively referred to as “Cadbury” unless otherwise indicated. Kraft Foods Inc., which acquired Cadbury on February 2, 2010, is hereafter referred to as “Kraft”.

 

The periods presented in this section are the years ended December 31, 2009, 2008 and 2007, which we refer to as “2009,” “2008” and “2007”, respectively.

 

Business Overview

 

We are a leading integrated brand owner, manufacturer and distributor of non-alcoholic beverages in the United States, Canada and Mexico with a diverse portfolio of flavored carbonated soft drinks (“CSDs”) and non-carbonated beverages (“NCBs”), including ready-to-drink teas, juices, juice drinks and mixers. Our brand portfolio includes popular CSD brands such as Dr Pepper, Sunkist soda, 7UP, A&W, Canada Dry, Crush, Squirt, Peñafiel, Schweppes and Venom Energy, and NCB brands such as Snapple, Mott’s, Hawaiian Punch, Clamato, Rose’s and Mr & Mrs T mixers. Our largest brand, Dr Pepper, is a leading flavored CSD in the United States according to The Nielsen Company. We have some of the most recognized beverage brands in North America, with significant consumer awareness levels and long histories that evoke strong emotional connections with consumers.

 

We operate primarily in the United States, Mexico and Canada and we also distribute our products in the Caribbean. In 2009, 90% of our net sales were generated in the United States, 4% in Canada and 6% in Mexico and the Caribbean.

 

Our Business Model

 

We operate as a brand owner, a manufacturer and a distributor.

 

Our Brand Ownership Businesses.  As a brand owner, we build our brands by promoting brand awareness through marketing, advertising and promotion and by developing new and innovative products and product line extensions that address consumer preferences and needs. As the owner of the formulas and proprietary know-how required for the preparation of beverages, we manufacture, sell and distribute beverage concentrates and syrups used primarily to produce CSDs and we manufacture, sell and distribute primarily finished NCBs. Most of our sales of beverage concentrates are to bottlers who manufacture, bottle, sell and distribute our branded products into retail channels. We also manufacture, sell and distribute syrups for use in beverage fountain dispensers to restaurants and retailers, as well as to fountain wholesalers, who resell it to restaurants and retailers. In addition, we distribute finished NCBs through ourselves and through third party distributors.

 

Our beverage concentrates and brand ownership businesses are characterized by relatively low capital investment, raw materials and employee costs. Although the cost of building or acquiring an established brand can be significant, established brands typically do not require significant ongoing expenditures, other than marketing, and therefore generate relatively high margins. Our packaged beverages brand ownership businesses have characteristics of both of our beverage concentrates and brand ownership businesses as well as our manufacturing and distribution businesses discussed below.

Our Manufacturing and Distribution Businesses.  We manufacture, sell and distribute finished CSDs from concentrates and finished NCBs and products mostly from ingredients other than concentrates. We sell and distribute packaged beverages and other products primarily into retail channels either directly to retail shelves or to warehouses through our large fleet of delivery trucks or through third party logistics providers.

 

Our manufacturing and distribution businesses are characterized by relatively high capital investment, raw material, selling and distribution costs, in each case compared to our beverage concentrates and brand ownership businesses. Our capital costs include investing in, and maintaining, our manufacturing and warehouse equipment and facilities. Our raw material costs include purchasing beverage concentrates, ingredients and packaging materials from a variety of suppliers. Our selling and distribution costs include significant costs related to operating our large fleet of delivery trucks and employing a significant number of employees to sell and deliver finished beverages and other products to retailers. As a result of the high fixed costs associated with these types of businesses, we are focused on maintaining an adequate level of volumes as well as controlling capital expenditures, raw material, selling and distribution costs. In addition, geographic proximity to our customers is a critical component of managing the high cost of transporting finished beverages relative to their retail price. The profitability of the manufacturing and distribution businesses is also dependent upon our ability to sell our products into higher margin channels. As a result of these factors, the margins of our manufacturing and distribution businesses are significantly lower than those of our brand ownership businesses. In light of the largely fixed cost nature of the manufacturing and distribution businesses, increases in costs, for example raw materials tied to commodity prices, could have a significant negative impact on the margins of our businesses.

 

Approximately 87% of our 2009 Packaged Beverages net sales of branded products come from our own brands, with the remaining from the distribution of third party brands such as FIJI mineral water and AriZona tea. In addition, a small portion of our Packaged Beverages sales come from bottling beverages and other products for private label owners or others for a fee.

 

Integrated Business Model.  We believe our brand ownership, manufacturing and distribution are more integrated than the United States operations of our principal competitors and that this differentiation provides us with a competitive advantage. We believe our integrated business model:

 

 

Trends Affecting our Business

 

We believe the key trends influencing the North American liquid refreshment beverage market include:

 

 

 

Seasonality

 

The beverage market is subject to some seasonal variations. Our beverage sales are generally higher during the warmer months and also can be influenced by the timing of holidays as well as weather fluctuations.

 

Segments

 

We report our business in three operating segments: Beverage Concentrates, Packaged Beverages and Latin America Beverages.

 

The key financial measures management uses to assess the performance of our segments are net sales and segment operating profit (loss) (“SOP”).

 

Beverage Concentrates

 

Our Beverage Concentrates segment is principally a brand ownership business. In this segment we manufacture and sell beverage concentrates in the United States and Canada. Most of the brands in this segment are CSD brands. In 2009, our Beverage Concentrates segment had net sales of approximately $1.1 billion. Key brands include Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry, Crush, Schweppes, Squirt, RC Cola, Diet Rite, Sundrop, Welch’s, Vernors, Country Time and the concentrate form of Hawaiian Punch.

 

We are the industry leader in flavored CSDs with a 40.3% market share in the United States for 2009, as measured by retail sales according to The Nielsen Company. We are also the third largest CSD brand owner as measured by 2009 retail sales in the United States and Canada and we own a leading brand in most of the CSD categories in which we compete.

 

Almost all of our beverage concentrates are manufactured at our plant in St. Louis, Missouri.

 

The beverage concentrates are shipped to third party bottlers, as well as to our own manufacturing systems, who combine them with carbonation, water, sweeteners and other ingredients, package it in PET containers, glass bottles and aluminum cans, and sell it as a finished beverage to retailers. Beverage concentrates are also manufactured into syrup, which is shipped to fountain customers, such as fast food restaurants, who mix the syrup with water and carbonation to create a finished beverage at the point of sale to consumers. Dr Pepper represents most of our fountain channel volume. Concentrate prices historically have been reviewed and adjusted at least on an annual basis.

Our Beverage Concentrates brands are sold by our bottlers, including our own Packaged Beverages segment, through all major retail channels including supermarkets, fountains, mass merchandisers, club stores, vending machines, convenience stores, gas stations, small groceries, drug chains and dollar stores. Unlike the majority of our other CSD brands, 72% of Dr Pepper volumes are distributed through the Coca-Cola affiliated and PepsiCo affiliated bottler systems.

 

Pepsi Bottling Group, Inc. (“PBG”) and Coca-Cola Enterprises, Inc. (“CCE”) are the two largest customers of the Beverage Concentrates segment, and constituted approximately 25% and 23%, respectively, of net sales during 2009.

 

Packaged Beverages

 

Our Packaged Beverages segment is principally a brand ownership, manufacturing and distribution business. In this segment, we primarily manufacture and distribute packaged beverages and other products, including our brands, third party owned brands and certain private label beverages, in the United States and Canada. In 2009, our Packaged Beverages segment had net sales of approximately $4.1 billion. Key NCB brands in this segment include Snapple, Mott’s, Hawaiian Punch, Clamato, Yoo-Hoo, Country Time, Nantucket Nectars, ReaLemon, Mr and Mrs T, Rose’s and Margaritaville. Key CSD brands in this segment include Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry, Squirt, RC Cola, Welch’s, Vernors, IBC, Mistic and Venom Energy.

 

Approximately 87% of our 2009 Packaged Beverages net sales of branded products come from our own brands, with the remaining from the distribution of third party brands such as FIJI mineral water and AriZona tea. A portion of our sales also comes from bottling beverages and other products for private label owners or others for a fee. Although the majority of our Packaged Beverages’ net sales relate to our brands, we also provide a route-to-market for third party brand owners seeking effective distribution for their new and emerging brands. These brands give us exposure in certain markets to fast growing segments of the beverage industry with minimal capital investment.

 

Our Packaged Beverages’ products are manufactured in multiple facilities across the United States and are sold or distributed to retailers and their warehouses by our own distribution network or by third party distributors. The raw materials used to manufacture our products include aluminum cans and ends, glass bottles, PET bottles and caps, paper products, sweeteners, juices, water and other ingredients.

 

We sell our Packaged Beverages’ products both through our Direct Store Delivery system (“DSD”), supported by a fleet of more than 5,000 trucks and approximately 12,000 employees, including sales representatives, merchandisers, drivers and warehouse workers, as well as through our Warehouse Direct delivery system (“WD”), both of which include the sales to all major retail channels, including supermarkets, fountain channel, mass merchandisers, club stores, vending machines, convenience stores, gas stations, small groceries, drug chains and dollar stores.

 

In 2009, Wal-Mart Stores, Inc., the largest customer of our Packaged Beverages segment, accounted for approximately 17% of our net sales in this segment.

 

Latin America Beverages

 

Our Latin America Beverages segment is a brand ownership, manufacturing and distribution business. This segment participates mainly in the carbonated mineral water, flavored CSD, bottled water and vegetable juice categories, with particular strength in carbonated mineral water and grapefruit flavored CSDs. In 2009, our Latin America Beverages segment had net sales of $357 million with our operations in Mexico representing approximately 88% of the net sales of this segment. Key brands include Peñafiel, Squirt, Clamato and Aguafiel.

 

In Mexico, we manufacture and distribute our products through our bottling operations and third party bottlers and distributors. In the Caribbean, we distribute our products through third party bottlers and distributors. In Mexico, we also participate in a joint venture to manufacture Aguafiel brand water with Acqua Minerale San Benedetto. We provide expertise in the Mexican beverage market and Acqua Minerale San Benedetto provides expertise in water production and new packaging technologies.

We sell our finished beverages through all major Mexican retail channels, including the “mom and pop” stores, supermarkets, hypermarkets, and on premise channels.

 

Acquisitions

 

On July 11, 2007, we acquired Southeast-Atlantic Beverage Corporation (“SeaBev”). SeaBev is included in our consolidated statements of operations beginning on its date of acquisition.

 

Volume

 

In evaluating our performance, we consider different volume measures depending on whether we sell beverage concentrates or finished beverages.

 

Beverage Concentrates Sales Volume

 

In our Beverage Concentrates segment, we measure our sales volume in two ways: (1) “concentrates case sales” and (2) “bottler case sales.” The unit of measurement for both concentrates case sales and bottler case sales equals 288 fluid ounces of finished beverage, or 24 twelve ounce servings.

 

Concentrates case sales represent units of measurement for concentrates sold by us to our bottlers and distributors. A concentrates case is the amount of concentrate needed to make one case of 288 fluid ounces of finished beverage. It does not include any other component of the finished beverage other than concentrate. Our net sales in our concentrates businesses are based on concentrates cases sold.

 

Although our net sales in our concentrates businesses are based on concentrates case sales, we believe that bottler case sales are also a significant measure of our performance because they measure sales of our finished beverages into retail channels.

 

Packaged Beverages Sales Volume

 

In our Packaged Beverages segment, we measure volume as case sales to customers. A case sale represents a unit of measurement equal to 288 fluid ounces of packaged beverage sold by us. Case sales include both our owned-brands and certain brands licensed to and/or distributed by us.

 

Volume in Bottler Case Sales

 

In addition to sales volume, we also measure volume in bottler case sales (“volume (BCS)”) as sales of packaged beverages, in equivalent 288 fluid ounce cases, sold by us and our bottlers to retailers and independent distributors.

 

Bottler case sales and concentrates and packaged beverage sales volumes are not equal during any given period due to changes in bottler concentrates inventory levels, which can be affected by seasonality, bottler inventory and manufacturing practices, and the timing of price increases and new product introductions.

 

Results of Operations

 

Executive Summary — 2009 Financial Overview and Recent Developments

 

 

 

For the periods prior to May 7, 2008, our consolidated financial statements have been prepared on a “carve-out” basis from Cadbury’s consolidated financial statements using historical results of operations, assets and liabilities attributable to Cadbury’s Americas Beverages business and including allocations of expenses from Cadbury. The historical Cadbury’s Americas Beverages information is our predecessor financial information. We eliminate from our financial results all intercompany transactions between entities included in the combination and the intercompany transactions with our equity method investees. On May 7, 2008, we became an independent company.

 

References in the financial tables to percentage changes that are not meaningful are denoted by “NM.”

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

Consolidated Operations

 

The following table sets forth our consolidated results of operation for the years ended December 31, 2009 and 2008 (dollars in millions).

 

 

Volume

 

Volume (BCS) increased 3% for the year ended December 31, 2009 compared with the year ended December 31, 2008. CSDs increased 4% and NCBs increased 2%. The absence of Hansen sales following the contract termination settlement in the United States and Mexico negatively impacted both total volumes and CSD volumes by 1% for the year ended December 31, 2009. In CSDs, Dr Pepper increased 2% led by the launch of the Cherry line extensions and strength in Diet Dr Pepper. 7UP, Sunkist soda, A&W and Canada Dry (collectively, our “Core 4 brands”) remained flat while Squirt decreased 8%. Driven by expanded distribution, the Crush brand grew 198%, which added an additional 48 million cases in 2009 in Beverage Concentrates and Latin America Beverages. In NCBs, 14% growth in Hawaiian Punch and 8% growth in Mott’s were partially offset by declines of 11% in Snapple and 1% in both Aguafiel and Clamato. Aguafiel declined 1% reflecting price increases and a more competitive environment. Snapple volumes declined primarily due to higher net pricing associated with the Snapple premium product restage and the impact of a continued slowdown in consumer spending on premium beverage products. In 2009, we extended and repositioned our Snapple offerings to support the long term health of the brand.

 

In North America volume increased 3% and in Mexico and the Caribbean volume increased 2%.

 

Net Sales

 

Net sales decreased $179 million, or 3%, for the year ended December 31, 2009 compared with the year ended December 31, 2008. The impact of the contract termination settlement with Hansen reduced net sales for the year ended December 31, 2009 by $218 million. Additionally, the impact of foreign currency reduced net sales by approximately $77 million. These decreases were partially offset by price increases and an increase in volumes, primarily driven by the expanded distribution of Crush.

Gross Profit

 

Gross profit increased $177 million, or 6%, for the year ended December 31, 2009 compared with the year ended December 31, 2008. The increase is a result of several factors including a decrease in commodity costs, the impact of price increases and volume increases and the positive impact of the LIFO adjustment, partially offset by the impact of the Hansen termination and foreign currency. Gross profit for the year ended December 31, 2009, includes a LIFO benefit of $10 million, compared to a LIFO expense of $20 million for the year ended December 31, 2008. LIFO is an inventory costing method that assumes the most recent goods manufactured are sold first, which in periods of rising prices results in an expense that eliminates inflationary profits from net income. Gross margin was 59% and 55% for the years ended December 31, 2009 and 2008, respectively.

 

Income (Loss) from Operations

 

The $1,253 million increase in income from operations for the year ended December 31, 2009 compared with the year ended December 31, 2008 was primarily driven by the absence of impairment of goodwill and intangible assets in 2009, an increase in gross profit, a reduction in restructuring costs and one-time gains of $62 million primarily related to the termination of distribution agreements. In October 2008, Hansen notified us that it was terminating our agreements to distribute Monster Energy as well as other Hansen’s branded beverages in the U.S. effective November 10, 2008. In December 2008, Hansen notified us that it was were terminating the agreement to distribute Monster Energy drinks in Mexico, effective January 26, 2009.

 

Our annual impairment analysis, performed as of December 31, 2009, resulted in no impairment charges for 2009, compared to non-cash impairment charges of $1,039 million for 2008.

 

The pre-tax impairment charges in 2008 consisted of $278 million related to the Snapple brand, $581 million of distribution rights and $180 million of goodwill related to the DSD reporting unit. Deteriorating economic market conditions in the fourth quarter of 2008 triggered higher discount rates as well as lower volume and growth projections which drove these impairments. Indicative of the economic and market conditions, our average stock price declined 19% in the fourth quarter as compared to the average stock price from May 7, 2008, the date of our separation from Cadbury, through September 30, 2008. The impairment of the distribution rights was attributed to insufficient net economic returns above working capital, fixed assets and assembled workforce.

 

There were no restructuring costs for the year ended December 31, 2009. Restructuring costs of $57 million for the year ended December 31, 2008 were primarily due to a plan announced in October 2007 intended to create a more efficient organization that resulted in the reduction of employees in the Company’s corporate, sales and supply chain functions and the continued integration of DSD into our Packaged Beverages segment.

 

Selling, general and administrative (“SG&A”) expenses increased for 2009 primarily due to an increase in compensation-related costs and an increase in advertising and marketing of $53 million, partially offset by decreased transportation and warehousing costs of $69 million driven by supply chain network optimization efforts in addition to a decrease in fuel costs and carrier rates. In connection with our separation from Cadbury, we incurred transaction costs and other one time costs of $33 million for the year ended December 31, 2008.

 

Interest Expense, Interest Income and Other Income

 

Interest expense decreased $14 million compared with the year ago period. Interest expense for the year ended December 31, 2009, reflects our capital structure as a stand-alone company and principally relates to our Term Loan A facility and senior unsecured notes. As the Term Loan A was fully repaid prior to its maturity in December 2009, the Company recorded a $30 million expense from the write-off of deferred financing fees and $7 million expense from the de-designation of a cash flow hedge associated with the Term Loan A in interest expense. During the year ended December 31, 2008, we incurred $26 million related to our bridge loan facility, including $21 million of financing fees expensed when the bridge loan facility was terminated on April 30, 2008, and additional interest expense on debt balances with subsidiaries of Cadbury prior to our separation.

 

The $28 million decrease in interest income was primarily due to the loss of interest income earned on note receivable balances with subsidiaries of Cadbury prior to our separation.

Other income of $22 million in 2009 includes $6 million related to indemnity income associated with the Tax Sharing and Indemnification Agreement (“Tax Indemnity Agreement”) with Cadbury and an additional $16 million of one-time separation related items resulting from an audit settlement during the third quarter of 2009.

 

Provision for Income Taxes

 

The effective tax rates for 2009 and 2008 were 36.3% and 16.3%, respectively. The 2009 tax rate is higher than 2008 primarily because the 2008 tax rate reflects that the tax benefit provided on the 2008 impairment charge is at an effective rate lower than our statutory rate primarily due to limits on the tax benefit provided against goodwill. However, the 2009 tax rate also includes a reduced level of nonrecurring separation related costs, benefits due to tax planning, and decreased state tax rates which reduced our deferred tax liabilities. These benefits were partly offset by additional tax expense related to a change in Mexican tax law enacted in the fourth quarter.

 

Results of Operations by Segment

 

We report our business in three segments: Beverage Concentrates, Packaged Beverages and Latin America Beverages. The key financial measures management uses to assess the performance of our segments are net sales and SOP. The following tables set forth net sales and SOP for our segments for 2009 and 2008, as well as the adjustments necessary to reconcile our total segment results to our consolidated results presented in accordance with U.S. GAAP (dollars in millions).

 

 

Beverage Concentrates

 

The following table details our Beverage Concentrates segment’s net sales and SOP for 2009 and 2008 (dollars in millions):

 

 

Net sales for the year ended December 31, 2009, increased $80 million compared with year ended December 31, 2008, due to a 6% increase in volumes as well as concentrate price increases. The expanded distribution of Crush added an incremental $74 million to net sales for the year ended December 31, 2009. The increase in net sales was partially offset by higher fountain food service discounts and coupon spending.

 

SOP increased $61 million for the year ended December 31, 2009, as compared with the year the ended December 31, 2008, primarily driven by the increase in net sales and favorable manufacturing and distribution costs partially offset by increased marketing investments and higher personnel costs.

 

Volume (BCS) increased 5% for the year ended December 31, 2009, compared with the year ended December 31, 2008, primarily driven by the expanded distribution of Crush, which added an incremental 44 million cases in 2009. Dr Pepper increased 2% led by the launch of the Cherry line extensions and strength in Diet Dr Pepper. The volume of our Core 4 brands declined 1%.

 

Packaged Beverages

 

The following table details our Packaged Beverages segment’s net sales and SOP for 2009 and 2008 (dollars in millions):

 

 

Sales volumes increased less than 1% for the year ended December 31, 2009, compared with the year ended December 31, 2008. The absence of sales of Hansen’s products following the termination of that distribution agreement during the fourth quarter of 2008 negatively impacted total volumes by approximately 1%. Total CSD volumes increased 1% led by increases in Dr Pepper whose volumes increased high single digits led by the launch of the Cherry line extensions. Volumes for our Core 4 brands increased low single digits. Total NCB volumes increased 1% due to a shift to value products such as Hawaiian Punch, which increased low double digits, partially offset by volume declines in the other NCB brands.

 

Net sales decreased $194 million for the year ended December 31, 2009, compared with the year ended December 31, 2008. Hansen’s termination reduced net sales for the year ended December 31, 2009, by $200 million. Additionally, net sales were favorably impacted by volume and price/mix increases, primarily in CSDs, offset by unfavorable impact of product mix.

 

SOP increased $90 million for the year ended December 31, 2009, compared with the year ended December 31, 2008. The increase was driven primarily due to lower commodity costs, including packaging materials and sweeteners, and lower transportation and warehouse costs driven by supply chain network optimization efforts in addition to a decrease in fuel costs and carrier rates. These increases in SOP were partially offset by increased advertising and marketing costs and costs associated with information technology (“IT”) infrastructure upgrades. The Hansen’s termination reduced SOP by approximately $40 million.

Latin America Beverages

 

The following table details our Latin America Beverages segment’s net sales and SOP for 2009 and 2008 (dollars in millions):

 

 

Sales volumes increased 2% for the year ended December 31, 2009 compared with the year ended December 31, 2008. The increase in volumes was driven by additional distribution routes, gains in Crush with the introduction of new flavors in a 2.3 liter value offering which added an incremental 4 million cases in 2009, and gains in Peñafiel, which benefited from a new marketing campaign, partially offset by declines in Squirt.

 

Net sales decreased $65 million for the year ended December 31, 2009 compared with the year ended December 31, 2008 primarily due to the impact of changes in foreign currency, the termination of Hansen’s distribution agreement early in the first quarter of 2009, and an unfavorable impact related to product mix, partially offset by increases in sales volumes. The termination of the Hansen agreement reduced net sales by approximately $18 million.

 

SOP decreased $32 million for the year ended December 31, 2009 compared with the year ended December 31, 2008 primarily due to the devaluation of the Mexican peso, Hansen’s termination which had a net impact of $5 million, a shift to value products and an increase in costs associated with distribution route expansion, partially offset by increased sales volume.

 

Accounting for the Separation from Cadbury

 

Upon separation, effective May 7, 2008, we became an independent company, which established a new consolidated reporting structure. For the periods prior to May 7, 2008, our consolidated financial information has been prepared on a “carve-out” basis from Cadbury’s consolidated financial statements using the historical results of operations, assets and liabilities, attributable to Cadbury’s Americas Beverages business and including allocations of expenses from Cadbury. The results may not be indicative of our future performance and may not reflect our financial performance had we been an independent publicly-traded company during those prior periods.

Items Impacting the Consolidated Statements of Operations

 

The following transactions related to our separation from Cadbury were included in the Consolidated Statements of Operations for the year ended December 31, 2009 and 2008 (in millions):

 

 

 

 

Items Impacting Income Taxes

 

The consolidated financial statements present the taxes of our stand alone business and contain certain taxes transferred to us at separation in accordance with the Tax Indemnity Agreement between us and Cadbury. This agreement provides for the transfer to us of taxes related to an entity that was part of Cadbury’s confectionery business and therefore not part of our historical consolidated financial statements. The consolidated financial statements also reflect that the Tax Indemnity Agreement requires Cadbury to indemnify us for these taxes. These taxes and the associated indemnity may change over time as estimates of the amounts change. Changes in estimates will be reflected when facts change and those changes in estimate will be reflected in our statement of operations at the time of the estimate change. In addition, pursuant to the terms of the Tax Indemnity Agreement, if we breach certain covenants or other obligations or we are involved in certain change-in-control transactions, Cadbury may not be required to indemnify us for any of these unrecognized tax benefits that are subsequently realized.

 

Kraft acquired Cadbury on February 2, 2010 and, therefore, assumes responsibility for Cadbury’s indemnity obligations under the terms of the Tax Indemnity Agreement.

 

Refer to Note 12 of the Notes to our Audited Consolidated Financial Statements for further information regarding the tax impact of the separation.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Consolidated Operations

 

The following table sets forth our consolidated results of operation for the years ended December 31, 2008 and 2007 (dollars in millions).

 

 

Volume

 

Volume (BCS) declined 2% for the year ended December 31, 2008 as compared with the year ended December 31, 2007. CSDs declined 1% and NCBs declined 7%. The absence of glaceau brand (“glaceau”) sales following the termination of the distribution agreement in 2007 negatively impacted total volumes and NCB volumes by 1% and 7%, respectively. In CSDs, Dr Pepper declined 1% primarily due to continued declines in the “Soda Fountain Classics” line. Our Core 4 brands declined 2%, primarily related to a 7% decline in 7UP as the brand cycled the final stages of launch support for 7UP with 100% Natural Flavors and the re-launch of Diet 7UP, partially offset by a 3% increase in Canada Dry due to the launch of Canada Dry Green Tea Ginger Ale. In NCBs, 9% growth in Hawaiian Punch, 6% growth in Clamato and 2% growth in Mott’s were more than offset by declines of 17% in Aguafiel, 7% in Snapple and the loss of glaceau distribution rights. Aguafiel declined 17% reflecting price increases and a more competitive environment. Our Snapple volumes were down 7% as the brand overlapped 5% growth in the prior year driven by aggressive promotional activity that we chose not to repeat in 2008, as well as the impact of a weakened retail environment on our premium products. In North America volume declined 2% and in Mexico and the Caribbean volume declined 4%.

Net Sales

 

Net sales increased $15 million for 2008 compared with 2007, primarily due to price increases and an increase in concentrate sales as bottlers purchased more concentrate in advance of planned concentrate price increases. Concentrate price increases were effective in January 2009 compared with concentrate price increases which were made in February 2008. These increases were partially offset by a decline in sales volumes and an increase in discounts paid to customers. The termination of the glaceau distribution agreement on November 2, 2007, and the Hansen distribution agreement in the United States on November 10, 2008, reduced 2008 net sales by $227 million and $23 million, respectively. Net sales resulting from the acquisition of SeaBev in July 2007 added an incremental $61 million to 2008 consolidated net sales.

 

Gross Profit

 

Gross profit remained flat for 2008 compared with the prior year. Increased pricing largely offset the decrease in sales volumes, increased customer discounts and increased commodity costs across our segments. Gross profit for the year ended December 31, 2008, includes LIFO expense of $20 million, compared to $6 million in 2007. LIFO is an inventory costing method that assumes the most recent goods manufactured are sold first, which in periods of rising prices results in an expense that eliminates inflationary profits from net income. Gross margin was 55% for the years ended December 31, 2008 and 2007.

 

(Loss) Income from Operations

 

The $1,172 million decrease in income from operations for 2008 compared with 2007 was primarily driven by impairment charges of $1,039 million in 2008, a one time gain we recognized in 2007 of $71 million in connection with the termination of the glaceau distribution agreement and higher SG&A expenses in 2008, partially offset by lower restructuring costs.

 

Our annual impairment analysis, performed as of December 31, 2008, resulted in non-cash impairment charges of $1,039 million for 2008. The pre-tax charges consisted of $278 million related to the Snapple brand, $581 million of distribution rights and $180 million of goodwill related to the DSD reporting unit. Deteriorating economic and market conditions in the fourth quarter triggered higher discount rates as well as lower volume and growth projections which drove these impairments. Indicative of the economic and market conditions, our average stock price declined 19% in the fourth quarter of 2008 as compared to the average stock price from May 7, 2008, the date of our separation from Cadbury, through September 30, 2008. The impairment of the distribution rights was attributed to insufficient net economic returns above working capital, fixed assets and assembled workforce.

 

SG&A expenses increased for 2008 primarily due to separation related costs, higher transportation costs and increased payroll and payroll related costs. In connection with our separation from Cadbury, we incurred transaction costs and other one time costs of $33 million for 2008. We incurred higher transportation costs principally due to an increase of $22 million related to higher fuel prices. These increases were partially offset by benefits from restructuring initiatives announced in 2007, lower marketing costs and $12 million in lower stock-based compensation expense.

 

Restructuring costs of $57 million and $76 million for 2008 and 2007, respectively, were primarily due to a plan announced in October 2007 intended to create a more efficient organization that resulted in the reduction of employees in the Company’s corporate, sales and supply chain functions and the continued integration of DSD into other operations of the Company. Restructuring costs for 2007 were higher due to higher costs associated with the organizational restructuring as well as additional costs recognized for the integration of technology facilities and the closure of a facility.

 

The loss of the glaceau distribution agreement reduced 2008 income from operations by $40 million, excluding the one time gain from the payment we received on termination.

Interest Expense, Interest Income and Other Income

 

Interest expense increased $4 million reflecting our capital structure as a stand-alone company, principally relating to our Term Loan A and unsecured notes. Interest expense for 2008 contained $26 million related to our bridge loan facility, including $21 million of financing fees expensed when the bridge loan facility was terminated. In 2008, we incurred $160 million less interest expense related to debt owed to Cadbury and $19 million related to third party debt settlement.

 

The $32 million decrease in interest income was primarily due to the loss of interest income earned on note receivable balances with subsidiaries of Cadbury, partially offset as we earned interest income on the funds from the bridge loan facility and other cash balances.

 

Other income of $18 million in 2008 primarily related to indemnity income associated with the Tax Indemnity Agreement with Cadbury.

 

Provision for Income Taxes

 

The effective tax rates for 2008 and 2007 were 16.3% and 39.4%, respectively. The 2008 tax rate reflects that the tax benefit provided on the 2008 impairment charge is at an effective rate lower than our statutory rate primarily due to limits on the tax benefit provided against goodwill. The 2008 tax benefit also reflects expense of $19 million related to items for which Cadbury is obligated to indemnify us for under the Tax Indemnity Agreement as well as additional tax expense of $16 million driven by separation transactions.

 

Results of Operations by Segment

 

We report our business in three segments: Beverage Concentrates, Packaged Beverages and Latin America Beverages. The key financial measures management uses to assess the performance of our segments are net sales and SOP. The following tables set forth net sales and SOP for our segments for 2008 and 2007, as well as the adjustments necessary to reconcile our total segment results to our consolidated results presented in accordance with U.S. GAAP (dollars in millions).

 

 

 

Beverage Concentrates

 

The following table details our Beverage Concentrates segment’s net sales and SOP for 2008 and 2007 (dollars in millions):

 

 

Net sales for 2008 decreased $1 million compared with 2007 primarily due to an increase in fountain food service channel discounts. This decrease was partially offset by price increases and a favorable timing change of concentrate sales as bottlers purchased more concentrate in advance of planned concentrate price increases. Concentrate price increases were effective in January 2009 compared with price increases which were effective in February 2008.

 

SOP increased $14 million for 2008 as compared with 2007 driven by lower personnel costs, primarily due to savings generated from restructuring initiatives, and lower marketing costs.

 

Volume (BCS) was flat in 2008. Dr Pepper volumes were flat as a 1% gain in the fountain foodservice channel offset declines in the “Soda Fountain Classics” line. The Core 4 brands were flat with declines in 7UP as the brand cycled the final stages of launch support for 7UP with 100% Natural Flavors and the re-launch of Diet 7UP, partially offset by a 3% increase in Canada Dry resulting from the launch of Canada Dry Green Tea Ginger Ale.

Packaged Beverages

 

The following table details our Packaged Beverages segment’s net sales and SOP for 2008 and 2007 (dollars in millions):

 

 

Sales volume decreased by approximately 3% for 2008 compared to 2007. The termination of the glaceau distribution agreement on November 2, 2007 and the Hansen distribution agreement on November 10, 2008 reduced sales volume by 3%. A 2% decrease in CSD volume and a 10% decrease in Snapple volume as we chose not to repeat aggressive promotional activity used in 2007 and from the impact of a weakened retail environment on our premium products, were offset by a 15% increase in Hawaiian Punch volume, sales from recently launched products, including Venom Energy and A&W and Sunkist Ready-to-Drink Floats, and 2% volume increases in both Clamato and Mott’s.

 

Net sales increased $10 million for 2008 compared with 2007 reflecting sales volume declines offset by price increases primarily driven by the Mott’s brand. The termination of the glaceau and Hansen agreements reduced 2008 net sales by $227 million and $23 million, respectively. The acquisition of SeaBev in July 2007 added an incremental $79 million to our net sales in 2008.

 

SOP decreased $81 million for 2008 compared with 2007 primarily due to higher commodity and component costs, higher distribution costs and increased wage and benefit costs. These decreases were partially offset by the growth in net sales combined with lower marketing costs as we cycled the introduction of Accelerade and savings generated from restructuring initiatives. The termination of the glaceau agreement reduced SOP by $40 million, excluding a one time gain of $13 million from the payment we received on termination. The termination of the Hansen agreement reduced SOP by $3 million.

 

During 2008, our Packaged Beverages segment generated approximately $197 million and $38 million in net sales and operating profits, respectively, from sales of Hansen brands to third parties in the United States.

 

Latin America Beverages

 

The following table details our Latin America Beverages segment’s net sales and SOP for 2008 and 2007 (dollars in millions):

 

 

Sales volumes decreased 4% in 2008 compared with 2007, principally driven by the performance of Aguafiel and Peñafiel due to aggressive price competition.

 

Net sales increased $6 million in 2008 compared with 2007 primarily due to price increases and a favorable channel and product mix, partially offset by a decline in volumes.

 

SOP decreased $10 million in 2008 due to an increase in raw material costs combined with higher distribution and wage costs and volume declines, partially offset by the increase in net sales and lower marketing costs. Raw material costs were negatively affected both by higher costs of packaging materials and the Mexican Peso devaluation in the fourth quarter of 2008. An increase in distribution costs and wages resulted from additional distribution routes added during the year.

In a letter dated December 11, 2008, we received formal notification from Hansen terminating our agreements to distribute Monster Energy in Mexico effective January 26, 2009. During 2008, our Latin America Beverages segment generated approximately $19 million and $6 million in net sales and operating profits, respectively, from sales of Hansen brands to third parties in Mexico.

 

Accounting for the Separation from Cadbury

 

Upon separation, effective May 7, 2008, we became an independent company, which established a new consolidated reporting structure. For the periods prior to May 7, 2008, our consolidated financial information has been prepared on a “carve-out” basis from Cadbury’s consolidated financial statements using the historical results of operations, assets and liabilities, attributable to Cadbury’s Americas Beverages business and including allocations of expenses from Cadbury. The results may not be indicative of our future performance and may not reflect our financial performance had we been an independent publicly-traded company during those prior periods.

 

Settlement of Related Party Balances

 

Upon our separation from Cadbury, we settled debt and other balances with Cadbury, eliminated Cadbury’s net investment in us and purchased certain assets from Cadbury related to our business. The following debt and other balances were settled with Cadbury upon separation (in millions):

 

 

Items Impacting the Statement of Operations and Income Taxes

 

Certain transactions related to our separation from Cadbury were included in the statement of operations for the year ended December 31, 2008. Additionally, the consolidated financial statements present the taxes of our stand alone business and contain certain taxes transferred to us at separation in accordance with the Tax Indemnity Agreement agreed between us and Kraft, which acquired Cadbury on February 2, 2010. Refer to our Results of Operations for the Year Ended December 31, 2009 Compared to Year Ended December 31, 2008 for further information.

 

Items Impacting Equity

 

In connection with our separation from Cadbury, the following transactions were recorded as a component of Cadbury’s net investment in us (in millions):

 

Prior to May 7, 2008, our total invested equity represented Cadbury’s interest in our recorded assets. In connection with the distribution of our stock to Cadbury plc shareholders on May 7, 2008, Cadbury’s total invested equity was reclassified to reflect the post-separation capital structure of $3 million par value of outstanding common stock and contributed capital of $3,133 million.

 

Liquidity and Capital Resources

 

Trends and Uncertainties Affecting Liquidity

 

Customer and consumer demand for the Company’s products may be impacted by recession or other economic downturn in the United States, Canada, Mexico or the Caribbean, which could result in a reduction in our sales volume. Similarly, disruptions in financial and credit markets may impact the Company’s ability to manage normal commercial relationships with its customers, suppliers and creditors. These disruptions could have a negative impact on the ability of our customers to timely pay their obligations to us, thus reducing our cash flow, or our vendors to timely supply materials.

 

The Company could also face increased counterparty risk for our cash investments and our hedge arrangements. Declines in the securities and credit markets could also affect the Company’s pension fund, which in turn could increase funding requirements.

 

We believe that the following recent transactions and trends and uncertainties may impact liquidity:

 

 

Financing Arrangements

 

2009 Borrowings and Repayments

 

On November 20, 2009, the Board authorized the Company to issue up to $1.5 billion of debt securities through the Securities and Exchange Commission shelf registration process. At December 31, 2009, $650 million remained authorized to be issued following the issuance described below.

 

On December 21, 2009, the Company completed the issuance of $850 million aggregate principal amount of senior unsecured notes consisting of the 2011 and 2012 Notes due December 21, 2011 and December 21, 2012, respectively.

 

On December 30, 2009, the Company borrowed $405 million from the Revolver .

 

On December 31, 2009, the Company fully repaid the principal balance on the senior unsecured Term Loan A facility prior to its maturity.

 

Subsequent to December 31, 2009, the Company made optional repayments of $405 million which represented the outstanding principal balance on the Revolver as of December 31, 2009.

 

2008 Borrowings and Repayments

 

On March 10, 2008, the Company entered into arrangements with a group of lenders to provide an aggregate of $4.4 billion in senior financing. The arrangements consisted of a term loan A facility, a revolving credit facility and a bridge loan facility.

On April 11, 2008, these arrangements were amended and restated. The amended and restated arrangements consist of a $2.7 billion senior unsecured credit agreement that provided a $2.2 billion Term Loan A facility and a $500 million revolving credit facility (collectively, the “senior unsecured credit facility”) and a 364-day bridge credit agreement that provided a $1.7 billion bridge loan facility.

 

On May 7, 2008, in connection with the Company’s separation from Cadbury, $3,019 million was repaid to Cadbury. Prior to separation from Cadbury, the Company had a variety of debt agreements with other wholly-owned subsidiaries of Cadbury that were unrelated to DPS’ business.

 

During 2008, the Company completed the issuance of $1.7 billion aggregate principal amount of senior unsecured notes consisting of $250 million aggregate principal amount of 6.12% senior notes due May 1, 2013 (the “2013 Notes”), $1.2 billion aggregate principal amount of 6.82% senior notes due May 1, 2018 (the “2018 Notes”), and $250 million aggregate principal amount of 7.45% senior notes due May 1, 2038 (the “2038 Notes”).

 

During 2008, the Company repaid the $1.7 billion bridge loan facility and made combined mandatory and optional repayments toward the Term Loan A principal totaling $395 million.

 

The following is a description of the senior unsecured credit facility and the senior unsecured notes. The summaries of the senior unsecured credit facility and the senior unsecured notes are qualified in their entirety by the specific terms and provisions of the senior unsecured credit agreement and the indenture governing the senior unsecured notes, respectively, copies of which are included as exhibits to this Annual Report on Form 10-K.

 

Senior Unsecured Credit Facility

 

The Company’s senior unsecured credit agreement provides senior unsecured financing of up to $2.7 billion, consisting of:

 

 

Borrowings under the senior unsecured credit facility bear interest at a floating rate per annum based upon the London interbank offered rate for dollars (“LIBOR”) or the alternate base rate (“ABR”), in each case plus an applicable margin which varies based upon the Company’s debt ratings, from 1.00% to 2.50%, in the case of LIBOR loans and 0.00% to 1.50% in the case of ABR loans. The alternate base rate means the greater of (a) JPMorgan Chase Bank’s prime rate and (b) the federal funds effective rate plus one half of 1%. Interest is payable on the last day of the interest period, but not less than quarterly, in the case of any LIBOR loan and on the last day of March, June, September and December of each year in the case of any ABR loan. The average interest rate for the years ended December 31, 2009 and 2008 was 4.9% for each year. Interest expense was $129 million and $85 million, which included amortization of deferred financing costs of $16 million and $10 million, for the years ended December 31, 2009 and 2008, respectively. Deferred financing costs of $30 million were expensed when the Term Loan A was terminated upon repayment in December 2009.

 

The Company utilizes interest rate swaps to convert variable interest rates to fixed rates. See Note 10 of the Notes to our Audited Consolidated Financial Statements for further information regarding derivatives.

 

An unused commitment fee is payable quarterly to the lenders on the unused portion of the commitments in respect of the Revolver equal to 0.15% to 0.50% per annum, depending upon the Company’s debt ratings. The Company incurred $1 million in unused commitment fees in each year ended December 31, 2009 and 2008. Additionally, interest expense included $3 million and $2 million for amortization of deferred financing costs associated with the Revolver for the years ended December 31, 2009 and 2008, respectively.

The Company was required to pay annual amortization in equal quarterly installments on the aggregate principal amount of the Term Loan A equal to: (i) 10%, or $220 million, per year for installments due in the first and second years following the initial date of funding, (ii) 15%, or $330 million, per year for installments due in the third and fourth years following the initial date of funding, and (iii) 50%, or $1,100 million, for installments due in the fifth year following the initial date of funding. Principal amounts outstanding under the Revolver are due and payable in full at maturity.

 

All obligations under the senior unsecured credit facility are guaranteed by substantially all of the Company’s existing and future direct and indirect domestic subsidiaries.

 

The senior unsecured credit facility contains customary negative covenants that, among other things, restrict the Company’s ability to incur debt at subsidiaries that are not guarantors; incur liens; merge or sell, transfer, lease or otherwise dispose of all or substantially all assets; make investments, loans, advances, guarantees and acquisitions; enter into transactions with affiliates; and enter into agreements restricting its ability to incur liens or the ability of subsidiaries to make distributions. These covenants are subject to certain exceptions described in the senior credit agreement. In addition, the senior unsecured credit facility requires the Company to comply with a maximum total leverage ratio covenant and a minimum interest coverage ratio covenant, as defined in the senior credit agreement. The senior unsecured credit facility also contains certain usual and customary representations and warranties, affirmative covenants and events of default. As of December 31, 2009, the Company was in compliance with all financial covenant requirements.

 

Senior Unsecured Notes

 

The 2011 and 2012 Notes

 

In December 2009, the Company completed the issuance of $850 million aggregate principal amount of senior unsecured notes consisting of the 2011 and 2012 Notes. The discount associated with the 2011 and 2012 Notes was less than $1 million. The weighted average interest rate of the 2011 and 2012 Notes was 2.0% for the year ended December 31, 2009. The net proceeds from the sale of the debentures were used for repayment of existing indebtedness under the Term Loan A. Interest on the 2011 and 2012 Notes is payable semi-annually on June 21 and December 21. Interest expense was $1 million for the year ended December 31, 2009, including amortization of deferred financing costs of less than $1 million.

 

The Company utilizes interest rate swaps, effective December 21, 2009, to convert fixed interest rates to variable rates. See Note 10 of the Notes to our Audited Consolidated Financial Statements for further information regarding derivatives.

 

The indenture governing the 2011 and 2012 Notes, among other things, limits the Company’s ability to incur indebtedness secured by principal properties, to enter into certain sale and leaseback transactions and to enter into certain mergers or transfers of substantially all of DPS’ assets. The 2011 and 2012 Notes are guaranteed by substantially all of the Company’s existing and future direct and indirect domestic subsidiaries.

 

The 2013, 2018 and 2038 Notes

 

During 2008, the Company completed the issuance of $1,700 million aggregate principal amount of senior unsecured notes consisting of the 2013, 2018 and 2038 Notes. The weighted average interest rate of the 2013, 2018 and 2038 Notes was 6.8% for the years ended December 31, 2009 and 2008. Interest on the senior unsecured notes is payable semi-annually on May 1 and November 1 and is subject to adjustment. Interest expense was $117 million and $78 million, which included amortization of deferred financing costs of $1 million each for the years ended December 31, 2009 and 2008, respectively.

 

The indenture governing the senior unsecured notes, among other things, limits the Company’s ability to incur indebtedness secured by principal properties, to enter into certain sale and lease back transactions and to enter into certain mergers or transfers of substantially all of DPS’ assets. The senior unsecured notes are guaranteed by substantially all of the Company’s existing and future direct and indirect domestic subsidiaries.

Bridge Loan Facility and Separation from Cadbury

 

The Company’s bridge credit agreement provided a senior unsecured bridge loan facility in an aggregate principal amount of $1,700 million with a term of 364 days from the date the bridge loan facility is funded.

 

On April 11, 2008, DPS borrowed $1,700 million under the bridge loan facility to reduce financing risks and facilitate Cadbury’s separation of the Company. All of the proceeds from the borrowings were placed into interest-bearing collateral accounts. On April 30, 2008, borrowings under the bridge loan facility were released from the collateral account containing such funds and returned to the lenders and the 364-day bridge loan facility was terminated. For the year ended December 31, 2008, the Company incurred $24 million of costs associated with the bridge loan facility. Financing fees of $21 million, which were expensed when the bridge loan facility was terminated, and $5 million of interest expense were included as a component of interest expense. These costs were partially offset as the Company earned $2 million in interest income on the bridge loan while in escrow.

 

On May 7, 2008, upon the Company’s separation from Cadbury, the borrowings under the Term Loan A facility and the net proceeds of the senior unsecured notes were released to DPS from collateral accounts and escrow accounts. The Company used the funds to settle with Cadbury related party debt and other balances, eliminate Cadbury’s net investment in the Company, purchase certain assets from Cadbury related to DPS’ business and pay fees and expenses related to the Company’s credit facilities.

 

Use of Proceeds

 

We used the funds from the Term Loan A and the net proceeds of the 2013, 2018 and 2038 Notes to settle with Cadbury related party debt and other balances, eliminate Cadbury’s net investment in us, purchase certain assets from Cadbury related to our business and pay fees and expenses related to our credit facilities. We used the funds from the 2011 and 2012 Notes to partially repay principal associated with the Term Loan A.

 

Debt Ratings

 

As of December 31, 2009, our debt ratings were Baa3 with a stable outlook from Moody’s Investor Service and BBB-with a positive outlook from Standard & Poor’s. We are currently on positive watch by both rating agencies.

 

These debt ratings impact the interest we pay on our financing arrangements. A downgrade of one or both of our debt ratings could increase our interest expense and decrease the cash available to fund anticipated obligations.

 

Cash Management

 

Prior to separation, our cash was available for use and was regularly swept by Cadbury operations in the United States at its discretion. Cadbury also funded our operating and investing activities as needed. We earned interest income on certain related party balances. Our interest income has been reduced due to the settlement of the related party balances upon separation and, accordingly, we expect interest income for 2010 to be minimal.

 

Post separation, we fund our liquidity needs from cash flow from operations and amounts available under financing arrangements.

 

Capital Expenditures

 

Capital expenditures were $317 million, $304 million and $230 million for 2009, 2008 and 2007, respectively. Capital expenditures for all periods primarily consisted of expansion of our capabilities in existing facilities, cold drink equipment and IT investments for new systems. The increase in expenditures for 2009 compared with 2008 was primarily related to costs of a new manufacturing and distribution center in Victorville, California. The increase in 2008 compared with 2007 was primarily related to early stage costs of a new manufacturing and distribution center in Victorville, California. We continue to expect to incur discretionary annual capital expenditures, net of proceeds from disposals, in an amount equal to approximately 5% of our net sales which we expect to fund through cash provided by operating activities.

Restructuring

 

We have implemented restructuring programs from time to time and have incurred costs that are designed to improve operating effectiveness and lower costs. These programs have included closure of manufacturing plants, reductions in force, integration of back office operations and outsourcing of certain transactional activities. We recorded $57 million and $76 million of restructuring costs for 2008 and 2007, respectively. There were no significant restructuring costs in 2009. Refer to Note 13 of the Notes to our Audited Consolidated Financial Statements for further information.

 

Liquidity

 

Based on our current and anticipated level of operations, we believe that our proceeds from operating cash flows will be sufficient to meet our anticipated obligations for the next twelve months. To the extent that our operating cash flows are not sufficient to meet our liquidity needs, we may utilize cash on hand or amounts available under our Revolver.

 

The following table summarizes our cash activity for 2009, 2008 and 2007 (in millions):

 

 

Net Cash Provided by Operating Activities

 

Net cash provided by operating activities increased $156 million for the year ended December 31, 2009, compared with the year ended December 31, 2008. The $867 million increase in net income included a $1,039 million decrease in the non-cash impairment of goodwill and intangible assets, a $62 million increase in the gain on the disposal of intangible assets primarily due to a one-time gain recorded in 2009 upon the termination of the Hansen distribution agreement and an increase of $344 million in deferred income taxes driven by the impairment of intangible assets in 2008. Changes in working capital included an $80 million favorable increase in accounts payable and accrued expenses offset by a decrease of $50 million in other non-current liabilities. Accounts payable and accrued expenses increased primarily due to higher accruals for customer promotion and employee compensation, increased inventory purchases and improved cash management by paying vendors in accordance with invoice terms. Other non-current liabilities decreased primarily due to payments associated with the Company’s pension and postretirement employee benefit plans.

 

Net cash provided by operating activities in 2008 was $709 million compared to $603 million in 2007. The $809 million decrease in net income included a $1,033 million increase in the non-cash impairment of goodwill and intangible assets, an $83 million decrease in the gain on the disposal of assets due to a one-time gain recorded in 2007 upon the termination of the glaceau distribution agreement, an increase of $39 million in depreciation and amortization expense driven by higher capital expenditures and the amortization of capitalized financing costs and the impact of the write-off of $21 million of deferred financing costs related to our bridge loan facility. These amounts were partially offset by a decrease of $296 million in deferred income taxes driven by the impairment of intangible assets. Changes in working capital included a $71 million favorable decrease in inventory primarily due to improved inventory management and lower sales volumes offset by an increase of $43 million in trade accounts receivable and a $43 million decrease in accounts payable and accrued expenses. Trade accounts receivable increased despite reduced collection times due to an increase in sales in December 2008. Accounts payable and accrued expenses decreased primarily due to lower inventory purchases as we focus on inventory management. Cash provided by operations was also impacted by our separation from Cadbury.

Net Cash Provided by Investing Activities

 

The decrease of $1,325 million in cash provided by investing activities for the year ended December 31, 2009, compared with the year ended December 31, 2008, was primarily attributable to related party notes receivable due to the separation from Cadbury during 2008. For 2008, cash provided by net repayments of related party notes receivable of $1,375 million for 2008. We increased capital expenditures by $13 million in the current year, primarily due to the build out of the new manufacturing and distribution center in Victorville, California. Capital asset investments for both years primarily consisted of expansion of our capabilities in existing facilities, replacement of existing cold drink equipment, IT investments for new systems, and upgrades to the vehicle fleet. Additionally, cash used in investing activities for 2009 included $68 million in proceeds primarily from the termination of Hansen’s distributor agreement.

 

The increase of $2,161 million in cash provided by investing activities for the year ended December 31, 2008, compared with the year ended December 31, 2007, was primarily attributable to related party notes receivable due to the separation from Cadbury. For 2007, cash used in net issuances of related party notes receivable totaled $929 million compared with cash provided by net repayments of related party notes receivable of $1,375 million for 2008. We increased capital expenditures by $74 million in the current year, primarily due to early stage costs of a new manufacturing and distribution center in Victorville, California. Capital asset investments for both years primarily consisted of expansion of our capabilities in existing facilities, replacement of existing cold drink equipment, IT investments for new systems, and upgrades to the vehicle fleet. Additionally, cash used by investing activities for 2007 included $98 million in proceeds from the disposal of assets, primarily attributable to the termination of the glaceau distribution agreement, partially offset by net cash used in the acquisition of SeaBev.

 

Net Cash Provided by Financing Activities

 

The decrease of $1,071 million in cash used in financing activities for the year ended December 31, 2009, compared with the year ended December 31, 2008, was driven by payments of third party long-term debt partially offset by the proceeds from senior unsecured notes and the Revolver.

 

The following table summarizes the issuances and payments of third party and related party debt for 2009 and 2008 (in millions):

 

 

 

 

 

The increase of $2,140 million in cash used in financing activities for the year ended December 31, 2008, compared with the year ended December 31, 2007, was driven by the change in Cadbury’s investment as part of our separation from Cadbury and payments of third party long-term debt. This increase was partially offset by the issuances of third party long-term debt.

 

Cash and Cash Equivalents

 

Cash and cash equivalents were $280 million as of December 31, 2009, an increase of $66 million from $214 million as of December 31, 2008. The increase was primarily due to our overall improvement in our operating activities during 2009.

 

Our cash is used to fund working capital requirements, scheduled debt and interest payments, capital expenditures, income tax obligations and, in future years, will be used for dividend payments and repurchases of our common stock. Cash available in our foreign operations may not be immediately available for these purposes. Foreign cash balances constitute approximately 32% of our total cash position as of December 31, 2009.

 

Dividends

 

On November 20, 2009, the Company’s Board declared our first dividend of $0.15 per share on outstanding common stock, payable January 8, 2010 to shareholders of record at the close of business on December 21, 2009.

 

On February 3, 2010, the Company’s Board declared a dividend of $0.15 per share on the common stock of the Company, payable on April 9, 2010 to the stockholders of record at the close of business on March 22, 2010.

 

Common Stock Repurchases

 

On November 20, 2009, the Board authorized the repurchase of up to $200 million of the Company’s outstanding common stock over the next three years. Subsequent to the Board’s authorization, we did not repurchase any of our common stock during the remainder of 2009. Subsequent to December 31, 2009, the Board authorized the repurchase of an additional $800 million of the Company’s outstanding common stock, for a total of $1 billion authorized.

Contractual Commitments and Obligations

 

We enter into various contractual obligations that impact, or could impact, our liquidity. The following table summarizes our contractual obligations and contingencies at December 31, 2009 (in millions). Based on our current and anticipated level of operations, we believe that our proceeds from operating cash flows will be sufficient to meet our anticipated obligations. To the extent that our operating cash flows are not sufficient to meet our liquidity needs, we may utilize amounts available under our Revolver. Refer to Notes 9 and 15 of the Notes to our Audited Consolidated Financial Statements for additional information regarding the items described in this table.

 

 

 

 

In accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), we had $534 million of unrecognized tax benefits, related interest and penalties as of December 31, 2009, classified as a long-term liability. The table above does not reflect any payments related to tax reserves if it is not possible to make a reasonable estimate of the amount or timing of the payment.

Off-Balance Sheet Arrangements

 

There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our results of operations, financial condition, liquidity, capital expenditures or capital resources.

 

Other Matters

 

Agreement with PepsiCo, Inc.

 

On December 8, 2009, DPS agreed to license certain brands to PepsiCo, Inc. (“PepsiCo”) on closing of PepsiCo’s proposed acquisitions of PBG and PAS.

 

Under the new licensing agreements, PepsiCo will distribute Dr Pepper, Crush and Schweppes in the U.S. territories where these brands are currently distributed by PBG and PAS. The same will apply for Dr Pepper, Crush, Schweppes, Vernors and Sussex in Canada; and Squirt and Canada Dry in Mexico.

 

Under the agreements, DPS will receive a one-time cash payment of $900 million. The new agreement will have an initial period of twenty years with automatic twenty year renewal periods, and will require PepsiCo to meet certain performance conditions. The payment will be recorded as deferred revenue, which will be recognized as net sales ratably over the estimated 25-year life of the customer relationship.

 

Additionally, in U.S. territories where it has a distribution footprint, DPS will begin distributing certain owned and licensed brands, including Sunkist soda, Squirt, Vernors, Canada Dry and Hawaiian Punch, that were previously distributed by PBG and PAS.

 

On February 26, 2010, the Company completed the licensing of those brands to PepsiCo following PepsiCo’s acquisitions of PBG and PAS.

 

Critical Accounting Estimates

 

The process of preparing our consolidated financial statements in conformity with U.S. GAAP requires the use of estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses. Critical accounting estimates are both fundamental to the portrayal of a company’s financial condition and results and require difficult, subjective or complex estimates and assessments. These estimates and judgments are based on historical experience, future expectations and other factors and assumptions we believe to be reasonable under the circumstances. The most significant estimates and judgments are reviewed on an ongoing basis and revised when necessary. Actual amounts may differ from these estimates and judgments. We have identified the policies described below as our critical accounting estimates. See Note 2 of the Notes to our Audited Consolidated Financial Statements for a discussion of these and other accounting policies.

 

Revenue Recognition

 

We recognize sales revenue when all of the following have occurred: (1) delivery; (2) persuasive evidence of an agreement exists; (3) pricing is fixed or determinable; and (4) collection is reasonably assured. Delivery is not considered to have occurred until the title and the risk of loss passes to the customer according to the terms of the contract between the customer and us. The timing of revenue recognition is largely dependent on contract terms. For sales to customers that are designated in the contract as free-on-board destination, revenue is recognized when the product is delivered to and accepted at the customer’s delivery site. Net sales are reported net of costs associated with customer marketing programs and incentives, as described below, as well as sales taxes and other similar taxes.

 

Customer Marketing Programs and Incentives

 

The Company offers a variety of incentives and discounts to bottlers, customers and consumers through various programs to support the distribution of its products. These incentives and discounts include cash discounts, price allowances, volume based rebates, product placement fees and other financial support for items such as trade promotions, displays, new products, consumer incentives and advertising assistance. These incentives and discounts are reflected as a reduction of gross sales to arrive at net sales. The aggregate deductions from gross sales recorded in relation to these programs were approximately $3,419 million, $3,057 million and $3,159 million

in 2009, 2008 and 2007, respectively. During 2009, the Company upgraded its SAP platform in DSD. As part of the upgrade, DPS harmonized its gross list price structure across locations. The impact of the change increased gross sales and related discounts by equal amounts on customer invoices. Net sales were not affected. The amounts of trade spend are larger in our Packaged Beverages segment than those related to other parts of our business. Accruals are established for the expected payout based on contractual terms, volume-based metrics and/or historical trends and require management judgment with respect to estimating customer participation and performance levels.

 

Goodwill and Other Indefinite Lived Intangible Assets

 

In accordance with U.S. GAAP we classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. The majority of our intangible asset balance is made up of brands which we have determined to have indefinite useful lives. In arriving at the conclusion that a brand has an indefinite useful life, management reviews factors such as size, diversification and market share of each brand. Management expects to acquire, hold and support brands for an indefinite period through consumer marketing and promotional support. We also consider factors such as our ability to continue to protect the legal rights that arise from these brand names indefinitely or the absence of any regulatory, economic or competitive factors that could truncate the life of the brand name. If the criteria are not met to assign an indefinite life, the brand is amortized over its expected useful life.

 

We conduct tests for impairment in accordance with U.S. GAAP. For intangible assets with definite lives, we conduct tests for impairment if conditions indicate the carrying value may not be recoverable. For goodwill and intangible assets with indefinite lives, we conduct tests for impairment annually, as of December 31, or more frequently if events or circumstances indicate the carrying amount may not be recoverable. We use present value and other valuation techniques to make this assessment. If the carrying amount of goodwill or an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. For purposes of impairment testing we assign goodwill to the reporting unit that benefits from the synergies arising from each business combination and also assign indefinite lived intangible assets to our reporting units. We define reporting units as Beverage Concentrates, Latin America Beverages, and Packaged Beverages’ two reporting units, DSD and WD.

 

The impairment test for indefinite lived intangible assets encompasses calculating a fair value of an indefinite lived intangible asset and comparing the fair value to its carrying value. If the carrying value exceeds the estimated fair value, impairment is recorded. The impairment tests for goodwill include comparing a fair value of the respective reporting unit with its carrying value, including goodwill and considering any indefinite lived intangible asset impairment charges (“Step 1”). If the carrying value exceeds the estimated fair value, impairment is indicated and a second step (“Step 2”) analysis must be performed.

 

The tests for impairment include significant judgment in estimating the fair value of intangible assets primarily by analyzing forecasts of future revenues and profit performance. Fair value is based on what the intangible asset would be worth to a third party market participant. Discount rates are based on a weighted average cost of equity and cost of debt, adjusted with various risk premiums. These assumptions could be negatively impacted by various of the risks discussed in “Risk Factors” in this Annual Report on Form 10-K.

 

For our annual impairment analysis performed as of December 31, 2009 and 2008, methodologies used to determine the fair values of the assets included a combination of the income based approach and market based approach, as well as an overall consideration of market capitalization and our enterprise value. Management’s estimates, which fall under Level 3, are based on historical and projected operating performance, recent market transactions and current industry trading multiples.

 

As of December 31, 2009, the results of the Step 1 analysis indicated that the estimated fair value of our indefinite lived intangible assets and goodwill substantially exceeded their carrying values and, therefore, are not impaired.

 

The results of the Step 1 analyses performed as of December 31, 2008, indicated there was a potential impairment of goodwill in the DSD reporting unit as the book value exceeded the estimated fair value. As a result, Step 2 of the goodwill impairment test was performed for the reporting unit. The implied fair value of goodwill

determined in the Step 2 analysis was determined by allocating the fair value of the reporting unit to all the assets and liabilities of the applicable reporting unit (including any unrecognized intangible assets and related deferred taxes) as if the reporting unit had been acquired in a business combination. As a result of the Step 2 analysis, we impaired the entire DSD reporting unit’s goodwill.

 

The Step 2 analysis in 2008 resulted in non-cash charges of $1,039 million, which are reported in the line item impairment of goodwill and intangible assets in our consolidated statement of operations. A summary of the impairment charges for 2008 is provided below (in millions):

 

 

 

 

The following table summarizes the critical assumptions that were used in estimating fair value for our annual impairment tests performed as of December 31, 2008:

 

 

 

 

For the DSD reporting unit’s goodwill, keeping the residual operating income growth rate constant but changing the discount rate downward by 0.50% would indicate less of an impairment charge of approximately $60 million. Keeping the discount rate constant and increasing the residual operating income growth rate by 0.50% would indicate less of an impairment charge of approximately $10 million. An increase of 0.50% in the estimated operating income growth rate would reduce the goodwill impairment charge by approximately $75 million.

 

For the Snapple brand, keeping the residual operating income growth rate constant but changing the discount rate by 0.50% would result in a $45 million to $50 million change in the impairment charge. Keeping the discount rate constant but changing the residual operating income growth rate by 0.50% would result in a $30 million to $35 million change in the impairment charge of the Snapple brand. A change of 0.25% in the estimated operating income growth rate would change the impairment charge by approximately $25 million.

A change in the critical assumptions detailed above would not result in a change to the impairment charge related to distribution rights.

 

The results of our annual impairment tests indicated that the fair value of our indefinite lived intangible assets and goodwill not discussed above exceeded their carrying values and, therefore, were not impaired.

 

Based on triggering events in the second and third quarters of 2008, we performed interim impairment analyses of the Snapple Brand and the DSD reporting unit’s goodwill and concluded there was no impairment as of June 30 and September 30, 2008, respectively. However, deteriorating economic and market conditions in the fourth quarter triggered higher discount rates as well as lower volume and growth projections which drove the impairments of the DSD reporting unit’s goodwill, Snapple brand and the DSD reporting unit’s distribution rights recorded in the fourth quarter. Indicative of the economic and market conditions, our average stock price declined 19% in the fourth quarter as compared to the average stock price from May 7, 2008, the date of our separation from Cadbury, through September 30, 2008. The impairment of the distribution rights was attributed to insufficient net economic returns above working capital, fixed assets and assembled workforce.

 

Definite Lived Intangible Assets

 

Definite lived intangible assets are those assets deemed by the management to have determinable finite useful lives. Identifiable intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives as follows:

 

 

Stock-Based Compensation

 

We account for our stock-based compensation plans under U.S. GAAP, which requires the recognition of compensation expense in our Consolidated Statements of Operations related to the fair value of employee share-based awards. Determining the amount of expense for stock-based compensation, as well as the associated impact to our balance sheets and statements of cash flows, requires us to develop estimates of the fair value of stock-based compensation expense. The most significant factors of that expense that require estimates or projections include the expected volatility, expected lives and estimated forfeiture rates of stock-based awards. As we lack a meaningful set of historical data upon which to develop valuation assumptions, we have elected to develop certain valuation assumptions based on information disclosed by similarly-situated companies, including multi-national consumer goods companies of similar market capitalization and large food and beverage industry companies which have experienced an initial public offering since June 2001.

 

In accordance with U.S. GAAP, we recognize the cost of all unvested employee stock options on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures. Prior to our separation from Cadbury, we participated in certain employee share plans that contained inflation indexed earnings growth performance conditions. These plans were accounted for under the liability method of U.S. GAAP. In accordance with U.S. GAAP, a liability was recorded on the balance sheet until and, in calculating the income statement charge for share awards, the fair value of each award was remeasured at each reporting date until awards vested. We no longer participate in employee share plans that contain inflation indexed earnings growth performance conditions.

 

Pension and Postretirement Benefits

 

We have several pension and postretirement plans covering employees who satisfy age and length of service requirements. There are eleven stand-alone non-contributory defined benefit pension plans and six stand-alone postretirement plans. Depending on the plan, pension and postretirement benefits are based on a combination of factors, which may include salary, age and years of service.

Pension expense has been determined in accordance with the principles of U.S. GAAP. Our policy is to fund pension plans in accordance with the requirements of the Employee Retirement Income Security Act. Employee benefit plan obligations and expenses included in our Consolidated Financial Statements are determined from actuarial analyses based on plan assumptions, employee demographic data, years of service, compensation, benefits and claims paid and employer contributions.

 

The expense related to the postretirement plans has been determined in accordance with U.S. GAAP. We accrue the cost of these benefits during the years that employees render service to us in accordance with U.S. GAAP.

 

The calculation of pension and postretirement plan obligations and related expenses is dependent on several assumptions used to estimate the present value of the benefits earned while the employee is eligible to participate in the plans. The key assumptions we use in determining the plan obligations and related expenses include: (1) the interest rate used to calculate the present value of the plan liabilities; (2) employee turnover, retirement age and mortality; and (3) the expected return on plan assets. Our assumptions reflect our historical experience and our best judgment regarding future performance. Due to the significant judgment required, our assumptions could have a material impact on the measurement of our pension and postretirement obligations and expenses. Refer to Note 15 of the Notes to our Audited Consolidated Financial Statements for further information.

 

The effect of a 1% increase or decrease in the weighted-average discount rate used to determine the pension benefit obligations for U.S. plans would change the benefit obligation as of December 31, 2009, by approximately $24 million and $26 million, respectively. The effect of a 1% increase or decrease in the weighted-average assumptions used to determine the net periodic pension costs would change the costs for the year ended December 31, 2009, by approximately $3 million each.

 

Risk Management Programs

 

We retain selected levels of property, casualty, workers’ compensation, health and other business risks. Many of these risks are covered under conventional insurance programs with high deductibles or self-insured retentions. Accrued liabilities related to the retained casualty and health risks are calculated based on loss experience and development factors, which contemplate a number of variables including claim history and expected trends. These loss development factors are established in consultation with external insurance brokers and actuaries. At December 31, 2009 and 2008, we had accrued liabilities related to the retained risks of $68 million and $60 million, respectively, including both current and long-term liabilities. Prior to our separation from Cadbury, we participated in insurance programs placed by Cadbury. Prior to and upon separation, Cadbury retained the risk and accrued liabilities for the exposures insured under these insurance programs.

 

We believe the use of actuarial methods to estimate our future losses provides a consistent and effective way to measure our self-insured liabilities. However, the estimation of our liability is judgmental and uncertain given the nature of claims involved and length of time until their ultimate cost is known. The final settlement amount of claims can differ materially from our estimate as a result of changes in factors such as the frequency and severity of accidents, medical cost inflation, legislative actions, uncertainty around jury verdicts and awards and other factors outside of our control.

 

Income Taxes

 

Income taxes are computed and reported on a separate return basis and accounted for using the asset and liability approach in accordance with U.S. GAAP. This method involves determining the temporary differences between combined assets and liabilities recognized for financial reporting and the corresponding combined amounts recognized for tax purposes and computing the tax-related carryforwards at the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The resulting amounts are deferred tax assets or liabilities and the net changes represent the deferred tax expense or benefit for the year. The total of taxes currently payable per the tax return and the deferred tax expense or benefit represents the income tax expense or benefit for the year for financial reporting purposes.

We periodically assess the likelihood of realizing our deferred tax assets based on the amount of deferred tax assets that we believe is more likely than not to be realized. We base our judgment of the recoverability of our deferred tax asset primarily on historical earnings, our estimate of current and expected future earnings, prudent and feasible tax planning strategies, and current and future ownership changes.

 

As of December 31, 2009 and 2008, undistributed earnings considered to be permanently reinvested in non-U.S. subsidiaries totaled approximately $115 million and $124 million, respectively. Deferred income taxes have not been provided on this income as the Company believes these earnings to be permanently reinvested. It is not practicable to estimate the amount of additional tax that might be payable on these undistributed foreign earnings.

 

Our effective income tax rate may fluctuate on a quarterly basis due to various factors, including, but not limited to, total earnings and the mix of earnings by jurisdiction, the timing of changes in tax laws, and the amount of tax provided for uncertain tax positions.

 

Effect of Recent Accounting Pronouncements

 

Refer to Note 2 of the Notes to our Audited Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for a discussion of recent accounting standards and pronouncements.

 

 

We are exposed to market risks arising from changes in market rates and prices, including inflation, movements in foreign currency exchange rates, interest rates, and commodity prices. The Company does not enter into derivatives or other financial instruments for trading purposes.

 

Foreign Exchange Risk

 

The majority of our net sales, expenses, and capital purchases are transacted in United States dollars. However, we do have some exposure with respect to foreign exchange rate fluctuations. Our primary exposure to foreign exchange rates is the Canadian dollar and Mexican peso against the U.S. dollar. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses in our income statement as incurred. We use derivative instruments such as foreign exchange forward contracts to manage our exposure to changes in foreign exchange rates. As of December 31, 2009, the impact to net income of a 10% change in exchange rates is estimated to be approximately $14 million.

 

Interest Rate Risk

 

We centrally manage our debt portfolio and monitor our mix of fixed-rate and variable rate debt.

 

We are subject to floating interest rate risk with respect to amounts borrowed under our unsecured Revolver. We incurred $405 million of debt with floating interest rates under this facility. A change in the estimated interest rate on the outstanding balance of borrowings under the unsecured Revolver up or down by 1% will increase or decrease our earnings before provision for income taxes by approximately $4 million, respectively, on an annual basis. We will also have interest rate exposure for any additional amounts we may borrow in the future under the Revolver.

 

Interest Rate Fair Value Hedges

 

DPS enters into interest rate swaps to convert fixed-rate, long-term debt to floating-rate debt. These swaps are accounted for as fair value hedges under U.S. GAAP. These fair value hedges qualify for the short-cut method of recognition; therefore, no portion of these swaps is treated as ineffective.

In December 2009, the Company entered into two interest rate swaps having an aggregate notional amount of $850 million and durations ranging from two to three years in order to convert fixed-rate, long-term debt to floating rate debt. These swaps were entered into at the inception of the 2011 and 2012 Notes. See Notes 9 and 10 of the Notes to our Audited Consolidated Financial Statements for further information.

 

As a result of these interest rate swaps, the Company pays an average floating rate, which fluctuates semi-annually, based on LIBOR. The average floating rate to be paid by the Company as of December 31, 2009 was less than 1.0%. The average fixed rate to be received by the Company as of December 31, 2009 was 2.0%.

 

Interest Rate Economic Hedge

 

The Company had an interest rate swap originally designated as a cash flow hedge effective December 31, 2009, with a duration of 12 months and a $750 million notional amount that amortizes at the rate of $100 million every quarter and converts variable interest rates to fixed rates of 3.73%. As of December 31, 2009, the cash flow hedging was discontinued, but the interest rate swap had not been terminated. Borrowings under the Revolver have similar terms to the term loan A. In this case, there exists a natural hedging relationship in which changes in the fair value of the instruments act as an economic offset to changes in the fair value of the underlying items. Changes in the fair value of these instruments are recorded as interest expense throughout the term of the derivative instrument and are reported in the same line item as the hedged transaction.

 

Commodity Risks

 

We are subject to market risks with respect to commodities because our ability to recover increased costs through higher pricing may be limited by the competitive environment in which we operate. Our principal commodities risks relate to our purchases of aluminum, corn (for high fructose corn syrup), natural gas (for use in processing and packaging), PET and fuel.

 

We utilize commodities forward contracts and supplier pricing agreements to hedge the risk of adverse movements in commodity prices for limited time periods for certain commodities. The fair market value of these contracts as of December 31, 2009 was an asset of $10 million.

 

As of December 31, 2009, the impact to net income of a 10% change in market prices of these commodities is estimated to be approximately $22 million.