Operating and Financial Review
Information used by management to make decisionsRegular period management accounts are produced for review by the Chief Executive's Committee (CEC). These accounts are used by the CEC to make decisions and assess business performance. The key performance measures, which are monitored on a Group wide and regional basis by the CEC, are:
Explanation of management performance measuresIncluded within the above performance metrics are a number of management performance measurements, namely Underlying Profit from Operations, Underlying Operating margins and Free Cash Flow. back to top Underlying Earnings MeasuresThe table below reconciles "Underlying Profit from Operations", as we define it, to what we believe is the corresponding IFRS measure, which is Profit from Operations.
A segmental analysis of Underlying Profit from Operations is presented alongside Profit from Operations on pages 92 and 96 of the audited financial statements. In addition, we present "Underlying Earnings per Share", along with a reconciliation to Reported Earnings per Share in Note 13 to the audited financial statements. We calculate Underlying Earnings per Share, which is a non-GAAP measure, by adjusting Basic Earnings per Share to exclude the effects of the following:
The costs we are incurring in implementing the "Fuel for Growth" project and integrating acquired businesses are classified as Restructuring costs. Our four year "Fuel for Growth" initiative aims to reduce direct and indirect annual costs by £360 million by 2007. Achieving these benefits is expected to require total Restructuring spend of £500 million over the life of the project, with £300 million of capital expenditure. We view these costs as costs associated with investments in the future performance of the business and not part of the underlying performance trends of the business. Hence these Restructuring costs are separately disclosed in arriving at Profit from Operations on the face of the Income Statement. Our trade is the marketing, production and distribution of branded confectionery and beverage products. As part of our operations we may dispose of subsidiaries, associates, brands, investments and significant fixed assets that do not meet the requirements to be separately disclosed outside of continuing operations. These discrete activities form part of our operating activities and are reported in arriving at Profit from Operations, however we do not consider these items to be part of our trading activities. The gains and losses on these discrete items can be significant and can give rise to gains or losses in different reporting periods. Consequently, these items can have a significant impact on the absolute amount of and trend in Profit from Operations and Operating margins and are not included in the underlying performance trends of the business. Our performance is driven by the performance of our brands, some of which are predominantly internally generated (e.g., those within the EMEA business segment) and some of which have been acquired (e.g., those within the Americas Confectionery business segment). Certain of the acquired brands are assigned a finite life and result in an amortisation charge being recorded in arriving at Profit from Operations. There are no similar charges associated with our internally generated brands.We believe that excluding brand intangible amortisation from our measure of operating performance allows the operating performance of the businesses that were organically grown and those that have resulted from acquisitions to be analysed on a more comparable basis. We seek to apply IAS 39 hedge accounting to hedge relationships (principally under commodity contracts, foreign exchange forward contracts and interest rate swaps) where it is permissible, practical to do so and reduces overall volatility. Due to the nature of our hedging arrangements, in a number of circumstances, we are unable to obtain hedge accounting. We continue, however, to enter into these arrangements as they provide certainty of price and delivery for the commodities we purchase, the exchange rates applying to the foreign currency transactions we enter into and the interest rate that apply to our debt. These arrangements result in fixed and determined cash flows. We believe that these arrangements remain effective economic and commercial hedges. The effect of not applying hedge accounting under IAS 39 means that the reported results reflect the actual rate of exchange and commodity price ruling on the date of a transaction regardless of the cash flow paid at the predetermined rate of exchange and commodity price. In addition, any gain or loss accruing on open contracts at a reporting period end is recognised in the result for the period (regardless of the actual outcome of the contract on close-out). Whilst the impacts described above could be highly volatile depending on movements in exchange rates or commodity prices, this volatility will not be reflected in our cash flows, which will be based on the fixed or hedged rate. Therefore we make an adjustment to exclude these effects from our underlying performance measures. In order to provide comparable earnings information the tax impact of the above items is also excluded in arriving at Underlying Earnings. In addition, from time to time, there may be tax items that as a consequence of their size and nature are excluded from Underlying Earnings. In 2005, we recognised a deferred tax asset in the UK for the first time, which has resulted in a £104 million credit to the current year taxation charge. In addition, an intra-Group transfer of certain non-tax deductible intellectual property rights undertaken in anticipation of the disposal of Europe Beverages has resulted in the recognition of an £11 million tax credit in arriving at the profit for the period from discontinued operations. As a consequence of their size and one-off nature, these amounts have been excluded from the Underlying Earnings of the Group. For the reasons stated above, "Underlying Profit from Operations", "Underlying Earnings" and "Underlying Earnings per share" are used by the Group for internal performance analysis. They are the primary information seen and used in any decision making process by the CEC. The Group also uses underlying profit as a key component of its primary incentive compensation plans including the Annual Incentive Plan, the bonus scheme for all employees of the Group. "Underlying Profit from Operations", "Underlying Earnings" and "Underlying Earnings per Share" exclude certain costs, some of which affect the cash generation of the Group. Assessing and managing our performance on these measures alone might result in the concentration of greater effort on the control of those costs that are included in the underlying performance measures. In order to mitigate this risk, we also manage the business and set external targets for cash flow. The costs of restructuring projects are deducted in arriving at the cash flow measures we use and hence the careful monitoring of these costs is ensured. The CEC does not primarily review or analyse financial information on a GAAP basis for Profit from Operations, Earnings or Earnings per Share. As the CEC carries out its performance analysis, its decision making processes and incentivises employees based on "Underlying Profit from Operations", "Underlying Earnings" and "Underlying Earnings per Share" we believe that these measures provide additional information on our underlying performance trends to investors, prospective investors and investments analysts that should be provided alongside the equivalent GAAP measures. back to topFree Cash FlowReferences to "Free Cash Flow" refer to the amount of cash we generate after meeting all our obligations for interest, tax and dividends and after all capital investment.
Net interest paid includes interest paid (£230 million) less interest received (£31 million). Net capital expenditure includes purchases of property, plant and equipment (£298 million) less proceeds on disposal of property, plant and equipment (£37 million). Net dividends paid includes dividends paid (£261 million), dividends paid to minority interests (£7 million) less dividends received from associates (£11 million). "Free Cash Flow" is not a defined term under IFRS or US Generally Accepted Accounting Principles (US GAAP) and may not therefore be comparable with other similarly titled non-GAAP cash flow measures reported by other companies. Free Cash Flow is the measure we use for internal cash flow performance analysis and is the primary cash flow measure seen and used by the CEC. We believe that Free Cash Flow is a useful measure because it shows the amount of Cash Flow remaining after the cash generated by the Group through operations has been used to meet purposes over which the Group has little or no discretion such as taxation and interest costs or those which are characteristic of a continuing business, for example capital expenditure and dividends. "Free Cash Flow" therefore represents the amount of cash generated in the year by the underlying business and, provides investors with an indication of the net cash flows generated that may be used for or are required to be funded by other discretionary purposes such as investment in acquisitions, business disposals and the drawing and repayment of financing. In 2005, payments of £31 million made into our principal Group defined benefit pension arrangements in respect of past service deficits have been excluded from Free Cash Flow. These payments are part of a wider pension funding strategy totalling some £190 million in the period to 2008. We believe that the funding of these pension deficits is a discretionary use of Free Cash Flow comparable to the repayment of external borrowings and has therefore been added back in calculating the 2005 Free Cash Flow. We will continue this reporting practice in future years.We continue to report the cash cost of funding pension obligations arising in respect of current year service within Free Cash Flow. back to topNet DebtReferences to "Net Debt" refer to the total borrowings of our business, including both short-term and long-term bank loans, bonds and finance leases, after offsetting the cash and cash equivalents of the business and our short-term investments. The table below reconciles Net Debt, as we define it, to the corresponding IFRS balance sheet captions.
"Net Debt" is not a defined term under IFRS or US GAAP and may not therefore be comparable with other similarly titled non-GAAP debt measures reported by other companies. Net Debt is the measure we use for internal debt analysis. We believe that Net Debt is a useful measure as it indicates the level of indebtedness after taking account of the financial assets within our business that could be utilised to pay down debt. In addition the net debt balance provides an indication of the net borrowings on which we are required to pay interest. back to topExplanation of Performance AnalysisFollowing the announcement on 1 September 2005 of our intention to dispose of Europe Beverages and the subsequent completion of the disposal post year-end, Europe Beverages has been classified as a discontinued operation in accordance with IFRS 5. IFRS requires that the results of Europe Beverages be excluded from Revenue, Profit from Operations, Financing and Taxation and the after-tax result (including any disposal costs incurred in 2005) be shown as a single line item on the face of the Income Statement below Taxation, with a corresponding re-presentation of the prior period. Hence in the analysis that follows all reference to Revenue growth, Underlying Profit from Operations growth and Profit from Operations growth excludes Europe Beverages. For further details on Discountinued Operations see Disposal of Europe Beverages. IFRS requires that the Cash Flow Statement reflects the cash flows of the Group, including Europe Beverages and hence all cash flow analysis, including references to Free Cash Flow, include the contribution from Europe Beverages. The review below starts with an overview that analyses Revenue and Underlying Profit from Operations, including the impact of exchange rates, and acquisitions and disposals in 2005 and 2004, and the impact of the additional weeks trading in 2004. As part of the review there is an analysis of Marketing, Restructuring costs, Intangibles amortisation, Non-trading items, IAS 39 adjustments, Share of result in associates, Financing, Taxation, Discontinued operations, Minority interests, Dividends, Earnings per share, acquisitions and disposals, and the effect of exchange rates and inflation. Following the consolidated overview, there is a review of the comparative results of each of the four continuing business segments. Each segment reviews Revenue, Underlying Profit from Operations and Restructuring costs. Underlying Profit from Operations refers to each segment's Profit from Operations before Restructuring costs, Non-trading items, amortisation of brand intangibles and IAS 39 adjustment. This is the measure of profit or loss for each reportable segment used by the CEC and segment management. The meanings of certain terms used in this Operating and Financial Review are as follows: References to "constant exchange rates" refer to the method we use to analyse the effect on Revenue and Underlying Profit from Operations attributable to changes in exchange rates by recomputing the current year results using the prior year exchange rates and presenting the difference as exchange movements. References to "excluding acquisitions and disposals" are to "base business" growth excluding the first 12 months' impact of acquisitions and the last 12 months' impact of disposals. This impact is referred to as growth from acquisitions and disposals. Once an acquisition has lapped its acquisition date it is included within the base business results as there is a comparative period in the prior year results to compare the performance to. Acquisitions and disposals are excluded from the base business results as this provides comparisons of base business performance for users of the accounts. In 2005, Cadbury Schweppes' financial year consisted of 52 weeks. In 2004, Cadbury Schweppes had an additional week's trading: the statutory results for 2004 were for the 53 weeks to 2 January 2005. The extra week in 2004 resulted in additional revenue and profit from operations compared to 2005. In order to provide more meaningful comparisons and consistent with the approach adopted in the prior year, estimates of the additional revenues and profits generated in the 53rd week of 2004 have been excluded from the analysis of base business (2004 - 52 weeks). Management believes this provides the most consistent underlying 52 week like-for-like analysis. In 2004, it was not possible to quantify the exact profit impact of the 53rd week and in determining the impact on the prior year, management had to exercise judgment. Operating costs were allocated on a reasonable and consistent basis across the Group. These costs included direct costs allocated as a determinable gross margin percentage consistent with base business, costs separately identifiable as relating to the 53rd week and indirect costs pro-rated with additional days of sales. Interest has been adjusted for on a pro-rated basis. These adjustments were tax effected at the Group's 2004 underlying tax rate. References to "base business" or "normal growth" refer to changes in Revenue, Underlying Profit from Operations, underlying earnings per share and other financial measures from year to year not attributable to exchange rate movements, or acquisitions and disposals or the impact of the 53rd week. We believe that removing the effect of exchange rates, acquisitions and disposals and the impact of the additional weeks trading in 2004 provides shareholders with a meaningful comparison of year on year performance of the base business. A reconciliation of the reported results is included on the Operating Review. |
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