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American Beverage Co Ambev – ‘20-F/A’ for 12/31/04

On:  Wednesday, 8/3/05, at 4:00pm ET   ·   For:  12/31/04   ·   Accession #:  950157-5-571   ·   File #:  1-15194

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 8/03/05  American Beverage Co Ambev        20-F/A     12/31/04    5:6.6M                                   Cravath Swaine &...01/FA

Amendment to Annual Report of a Foreign Private Issuer   —   Form 20-F
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 20-F/A      Form 20F Amendment No. 1                            HTML   3.69M 
 2: EX-12.1     Principal Executive Officers' Certification (302)   HTML     20K 
 3: EX-12.2     Principal Financial Officer Certification (302)     HTML     14K 
 4: EX-13.1     Principal Executive Officers' Certification (906)   HTML     16K 
 5: EX-13.2     Principal Financial Officer Certification (906)     HTML     11K 


20-F/A   —   Form 20F Amendment No. 1


This is an HTML Document rendered as filed.  [ Alternative Formats ]



  Form 20F Amendment No. 1  
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 20-F/A
AMENDMENT NO. 1
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission file number: 1-15194
COMPANHIA DE BEBIDAS DAS AMÉRICAS - AMBEV
(Exact name of Registrant as specified in its charter)
 
 
American Beverage Company-AmBev
(Translation of Registrant’s name into English)
Federative Republic of Brazil
(Jurisdiction of incorporation or organization)
_____________________________
 
Rua Dr. Renato Paes de Barros, 1017, 4º andar
04530-001 São Paulo, SP, Brazil
(Address of principal executive offices)
_____________________________
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange
on which registered
 
                                   American Depositary Shares,
                                   evidenced by American Depositary
                                   Receipts, each representing
                                   100 Common Shares
 
 
                                  New York Stock Exchange
 
                                  Common Shares, no par value*
 
 
                                  American Depositary Shares,
                                  evidenced by American Depositary
        Receipts, each representing
                                  100 Preferred Shares
                                  New York Stock Exchange
 
 
                                  Preferred Shares, no par value*
 
__________________
 
*
Not for trading but only in connection with the registration of the American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
 
10.5% Notes due December 2011
8.75% Notes due September 2013
 


 
The number of total outstanding shares of each of the issuer’s classes of
capital or common stock as of May 31, 2005 was:
34,499,422,931 Common Shares
31,147,483,500 Preferred Shares
Indicate by checkmark 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 {X} No { }  Not Applicable { }
Indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 { } Item 18 {X}

 

 

 
EXPLANATORY NOTE

The Company is amending its annual report on Form 20-F for the year ended December 31, 2004 in order to (i) correct a typographical error in page F-3 as originally filed, (ii) include monthly and price per share detail of share buyback programs on Item 16E and (iii) clarify and conform disclosure relating to tax assessments earnings of our foreign subsidiaries contained in  “Operating and Financial Review and Prospects—Critical Accounting Policies—Unrecognized Exposures” and “Operating and Financial Review and Prospects—Off Balance Sheet Arrangements” and in “Financial Information—Tax Matters—Income Tax and Social Contribution”.

No other changes are being made to this annual report on Form 20-F, as originally filed, although Exhibits 12.1, 12.2, 13.1 and 13.2 have been refiled in their current form. The annual report, as amended by this amendment, continues to speak as of the date of its original filing, and the Company has not updated the disclosure as of a later date.
 
 
 
 

 
TABLE OF CONTENTS

 
 
Page
 
INTRODUCTION
 
i
 
ACCOUNTING PERIODS AND PRINCIPLES
 
i
 
CURRENCY TRANSLATION
 
i
 
INDUSTRY DATA
 
ii
 
TRADEMARKS
 
ii
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
 
ii
 
Item 1.
 
Identity of Directors, Senior Management and Advisers
 
1
 
Item 2.
 
Offer Statistics and Expected Timetable
 
1
 
Item 3.
 
Key Information
 
1
 
Item 4.
 
Information on the Company
 
20
 
Item 5.
 
Operating and Financial Review and Prospects
 
45
 
Item 6.
 
Directors, Senior Management and Employees
 
79
 
Item 7.
 
Major Shareholders and Related Party Transactions
 
92
 
Item 8.
 
Financial Information
 
101
 
Item 9.
 
The Offer and Listing
 
110
 
Item 10.
 
Additional Information
 
116
 
Item 11.
 
Quantitative and Qualitative Disclosures about Market Risk
 
141
 
Item 12.
 
Description of Securities Other Than Equity Securities
 
142
 
Item 13.
 
Defaults, Dividend Arrearages and Delinquencies
 
144
 
Item 14.
 
Material Modifications to the Rights of Security Holders and Use of Proceeds
 
144
 
Item 15.
 
Disclosure Controls and Procedures
 
144
 
Item 16.
 
Reserved
 
144
 
 
Item 16A.
 
Audit Committee Financial Expert
 
144
 
 
Item 16B.
 
Code of Ethics
144
 
 
Item 16C.
 
Principal Accountant Fees and Services
 
145
 
 
Item 16D.
 
Exemptions from the Listing Standards for Audit Committees
 
146
 
 
Item 16E.
 
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
146
 
Item 18.
Financial Statements
 
146
Item 19.
Exhibits
 
147
SIGNATURES
 
152
 

 

 
INTRODUCTION
 
This annual report on Form 20-F relates to the two classes of registered American Depositary Shares (“ADSs”) of Companhia de Bebidas das Américas AmBev evidenced by American Depositary Receipts (“ADRs”) representing 100 preferred shares of AmBev and ADSs evidenced by ADRs representing 100 common shares, of AmBev, the U.S.$500,000,000 10½% notes due 2011 of AmBev (the “2011 notes”) and the U.S.$500,000,000 8.75% notes due 2013 of AmBev (the “2013 notes”, and together with the 2011 notes, the “notes”).
 
In this annual report, except as otherwise indicated or as the context otherwise requires, the “Company”, “AmBev”, “we”, “us” and “our” refers to Companhia de Bebidas das Américas - AmBev and its subsidiaries.
 
ACCOUNTING PERIODS AND PRINCIPLES
 
We have prepared our audited annual consolidated financial statements as of December 31, 20042003 and 2002, and for the three years ended December 31, 2004 in Brazilian Reais in accordance with accounting practices generally accepted in Brazil (“Brazilian GAAP”), which are based on Brazilian Corporate Law (Law No. 6,404, as amended, by Law No. 9,457/97 and Brazilian Law No. 10,303/01, which we refer to collectively as “Brazilian Corporate Law”), the rules and regulations issued by the Comissão de Valores Mobiliários (“CVM”), or the Brazilian Securities Commission, and the accounting standards issued by the Instituto dos Auditores Independentes do Brasil (“IBRACON”), or the Brazilian Institute of Independent Accountants), as applied by us in preparing our statutory financial statements and annual report and accounts, which differ in certain significant respects from accounting principles generally accepted in the United States (“U.S. GAAP”). The audited financial statements included in this annual report have been prepared in accordance with Brazilian GAAP and include a reconciliation of net income and shareholders’ equity to U.S. GAAP. In addition to the reconciliation of these key balances, the financial statements also include a discussion of the reconciling differences in accounting principles and the presentation of the U.S. GAAP condensed balance sheets and statement of operations in Brazilian Reais. The financial information contained in this annual report is in accordance with Brazilian GAAP, except as otherwise noted.
 
Percentages and some amounts in this annual report have been rounded for ease of presentation. Any discrepancies between totals and the sums of the amounts listed are due to rounding.
 
CURRENCY TRANSLATION
 
In this annual report, references to “real”, “reais” or “R$” are to the legal currency of Brazil, references  to “U.S. dollar” or “U.S.$” are to the legal currency of the United States and references to “Canadian dollar” or “C$” are to the legal currency of Canada. We have translated some of the Brazilian currency amounts contained in this annual report into U.S. dollars. We have also traslated some amounts from U.S. dollars and Canadian dollars into Reais. All financial information relating to us that is presented in U.S. dollars in this annual report has been translated from reais at the period end exchange rate or average exchange rate prevailing during the period, as published by the Central Bank of Brazil (“Central Bank”), unless the context otherwise requires. The exchange rate on May 31, 2005 was R$2.4038 to U.S.$1.00 as published by the Central Bank. The U.S. dollar equivalent information presented in this annual report is provided solely for the convenience of the readers of this annual report and should not be construed as implying that the Brazilian currency amounts represent, or could have been or could be converted into, U.S. dollars at such rates or at any rate. See “Key Information—Exchange Rate Information—Exchange Controls” for more detailed information regarding the translation of reais into U.S. dollars.
 
i

 
INDUSTRY DATA
 
In this annual report, we refer to information regarding the beverage market and its segments and competitors from:
 
ACNielsen
Contact: Antônio Marcio Mongelli Garotti
Rua Monte Castelo, 55
Granja Viana
Cotia - São Paulo
CEP 06710-675
Tel.: 55 11 4613 7000
www.acnielsen.com.br http://www.acnielsen.com.br
 
Canadean Ltd.
Contact: Kevin Baker
12 Faraday Court, Rankine Road, Daneshill
Basingstoke, Hants, England
RG24 8PF
Tel.: 44 1256 394200
www.canadean.com <http://www.canadean.com>
 
TRADEMARKS
 
This annual report includes names of our products which constitute trademarks or trade names which we own or which are owned by others and are licensed to us for our use. This annual report also contains other brand names, trade names, trademarks or service marks of other companies, and these brand names, trade names, trademarks or service marks are the property of those other companies.
 
CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING INFORMATION
 
We make forward-looking statements in this annual report that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of our management, and on information currently available to us. Forward-looking statements include statements regarding the intent, belief or current expectations of AmBev or its directors or executive officers with respect to, but not limited to:
 
·  
the declaration or payment of dividends;
 
·  
the direction of future operations;
 
·  
the implementation of principal operating strategies, including existing, potential acquisition or joint venture transactions or other investment opportunities;
 
·  
the implementation of AmBev’s financing strategy and capital expenditure plans;
 
·  
the utilization of AmBev’s subsidiaries’ income tax losses;
 
·  
the factors or trends affecting AmBev’s financial condition, liquidity or results of operations;
 
·  
the implementation of the measures required under AmBev’s performance agreement entered into with the Conselho Administrativo de Defesa Econômica (“CADE”); and
 
·  
the implementation of the measures required by Argentina’s Comision Nacional de Defensa de la Competencia (“CNDC”) under AmBev’s agreements with BAC and Quinsa.
 
 
ii

 
Forward-looking statements also include information concerning possible or assumed future results of operations of AmBev set forth under “Information on the Company—AmBev Business Overview” and “Financial Information” as well as statements preceded by, followed by, or that include, the words “believes”, “may”, “will”, “continues”, “expects”, “anticipates”, “intends”, “plans”, “estimates” or similar expressions.
 
Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. The future results and shareholder values of AmBev may differ materially from those expressed in or suggested by these forward-looking statements. Many of the factors that will determine these results and values are beyond our ability to control or predict. Investors are cautioned not to put undue reliance on any forward-looking statements.
 
Investors should understand that the following important factors, in addition to those discussed in this annual report, could affect the future results of AmBev and could cause results to differ materially from those expressed in such forward-looking statements:
 
·  
general economic conditions in the principal geographic markets of AmBev, such as the rates of economic growth, fluctuations in exchange rates or inflation;
 
·  
governmental intervention, resulting in changes to the economic, tax or regulatory environment in Brazil or other countries in which we operate;
 
·  
industry conditions, such as the strength of product demand, the intensity of competition, pricing pressures, the introduction of new products by AmBev, the introduction of new products by competitors, changes in technology or in the ability of AmBev to obtain products and equipment from suppliers without interruption and at reasonable prices, and the financial conditions of the customers and distributors of AmBev; and
 
·  
operating factors, such as the continued success of sales, manufacturing and distribution activities of AmBev and the consequent achievement of efficiencies.
 
 
iii

 

PART I
 
Identity of Directors, Senior Management and Advisers
 
Not Applicable.
 
Offer Statistics and Expected Timetable
 
Not Applicable.
 
Key Information
 
AMBEV’S SELECTED FINANCIAL DATA
 
The following financial information of AmBev is only a summary and should be read in conjunction with, and is qualified in its entirety by reference to, the audited annual consolidated financial statements of AmBev and the related notes which are included in this annual report.
 
Our selected historical financial data prepared under Brazilian GAAP and U.S. GAAP set forth below as of and for each of the years ended December 31, 2004, 2003, 2002, 2001 and 2000 have been derived from AmBev’s consolidated financial statements as of and for the periods then ended. Brazilian GAAP differs significantly from U.S. GAAP and you should read the financial information in conjunction with our audited financial statements, as well as “Operating and Financial Review and Prospects”.
 
On October 4, 2002, Companhia Brasileira de Bebidas (“CBB”) completed an exchange offer of the U.S.$500 million 10.5% notes due 2011, in the U.S. securities markets. Also, in September 2003, CBB issued U.S.$500 million 8.75% notes due 2013 in a transaction exempt from registration under the U.S. Securities Act of 1933. On September 15, 2004, CBB completed an exchange offer of such notes in the U.S. securities markets. AmBev fully and unconditionally guaranteed these two issuances, and following CBB’s merger into AmBev on May 31, 2005, succeeded CBB in all its rights and obligations under the indenture governing these notes.
 
Financial information relating to CBB has not been included within the Selected Financial Data, but full consolidating schedules disclosing the balance sheets, statements of operations and statements of cash flow as of December 31, 2004 and 2003 and for each of the years ended December 31, 2004, 2003 and 2002, under Brazilian GAAP, have been included in note 26  to our audited financial statements, contained within this document.
 
On August 27, 2004, AmBev completed the transactions contemplated by an agreement (the Incorporação Agreement) with InBev S.A./N.V. (“InBev”), Labatt Brewing Company Ltd. (“Labatt”) and Labatt Brewing Canada Holding Ltd., then a wholly owned susidiary of InBev (“Mergeco”), which indirectly held 100% of the capital stock of Labatt.  Pursuant to the Incorporação Agreement, Mergeco was merged into AmBev by means of an Incorporação under Brazilian law.  Mergeco held 99.9% of the capital stock of Labatt Holding ApS (“Labatt ApS”), a corporation organized under the laws of Denmark, and Labatt ApS owns all the capital stock of Labatt.  Upon completion of the Incorporação, AmBev held 100% of the capital stock of Labatt ApS, and indirectly, of Labatt, which constitutes our Canadian-based operations.  The results of operations for Labatt were fully consolidated for the period from August 27, 2004 until December 31, 2004 in our audited financial statements, and will be fully consolidated for future periods.
 

1



STATEMENT OF OPERATIONS DATA
 
 
 
As of or for the year ended December 31,
     
 
 
2003
 
 
2002
 
 
2001
 
 
2000
 
 
(R$ in millions, except for per share amounts,
number of shares and other operating data) 
Brazilian GAAP
                               
                                 
 
   
                                 
Gross sales, before taxes, discounts and returns
   
23,297.6
   
17,143.5
   
14,279.9
   
13,131.0
   
11,282.5
 
Net sales
   
12,006.8
   
8,683.8
   
7,325.3
   
6,525.6
   
5,250.4
 
Cost of sales
   
(4,780.5
)
 
(4,044.2
)
 
(3,341.7
)
 
(3,366.2
)
 
(2,843.7
)
Gross profit
   
7,226.3
   
4,639.6
   
3,983.6
   
3,159.4
   
2,406.7
 
Selling and marketing expenses
   
(1,582.8
)
 
(847.1
)
 
(687.2
)
 
(707.8
)
 
(578.6
)
Direct distribution expenses
   
(868.9
)
 
(648.6
)
 
(537.4
)
 
(467.8
)
 
(337.0
)
General and administrative expenses(1)
   
(617.9
)
 
(417.9
)
 
(373.5
)
 
(351.5
)
 
(373.0
)
Depreciation and amortization of deferred charges
   
(541.5
)
 
(420.0
)
 
(334.6
)
 
(256.5
)
 
(202.3
)
   
3,615.2
 
 
2,306.1
   
2,050.9
   
1,375.8
   
915.8
 
Provision for contingencies and other
   
(260.2
)
 
(187.9
)
 
(123.7
)
 
(33.9
)
 
(269.2
)
Other operating income, net(3)
   
(420.9
)  
(240.1
)  
199.4
   
152.2
   
9.1
 
Financial income
   
339.2
   
601.8
   
2,530.3
   
358.4
   
374.0
 
Financial expenses
   
(1,115.6
)
 
(508.7
)
 
(3,277.3
)
 
(861.5
)
 
(698.0
)
Equity in Investees
   
5.6
 
 
(6.2
)
 
-
   
-
   
-
 
Operating income(2)
   
2,163.3
   
1,964.9
   
1,379.6
   
991.0
   
331.7
 
Non-operating income (expense), net(3)
   
(333.9
)
 
(100.7
)
 
(72.2
)
 
2.3
   
52.7
 
Income tax benefit (expense)
   
(511.8
)
 
(426.1
)
 
280.6
   
(51.9
)
 
405.4
 
Income before equity in affiliates, profit sharing and minority interest
   
1,317.6
   
1,438.1
   
1,588.0
   
941.4
   
789.8
 
Profit sharing and contributions
   
(152.4
)
 
(23.6
)
 
(125.1
)
 
(157.1
)
 
(53.7
)
Minority interest
   
(3.7
)
 
(2.9
)
 
47.4
   
0.3
   
(265.9
)
Net income
   
1,161.5
   
1,411.6
   
1,510.3
   
784.6
   
470.2
 
                                 
Net income per 1,000 shares (excluding treasury shares) at year end(3)
   
21.26
   
37.23
   
39.48
   
20.31
   
12.19
 
Net income per ADS(4) at year end
   
2.13
   
3.72
   
3.95
   
2.03
   
1.22
 
Dividends and interest attributable to shareholder’s equity per 1,000 shares (excluding treasury shares)(3)(5) (6)
                               
Common shares
   
20.86
 
 
23.15
   
12.40
   
7.17
   
8.00
 
Preferred shares
   
22.95
 
 
25.46
   
13.64
   
7.89
   
8.37
 
Number of shares outstanding at year end, excluding treasury shares (in thousands) 
                               
Common shares
   
23,497,514
   
15,631,332
   
15,694,772
   
15,801,482
   
15,946,841
 
Preferred shares
   
31,129,892
   
22,281,302
   
22,551,143
   
22,819,443
   
22,616,017
 


2

 
 
 
 
 
As of or for the year ended December 31, 
 
       
2003
   
2002
   
2001
   
2000
 
 
(R$ in millions, except for per share amounts,
number of shares and other operating data) 
U.S. GAAP
 
                     
Net sales      9,377.9     7,929.4     7,310.4     6,566.3     4,821.5  
Operating income      2,878.7     2,038.2     1,569.2     1,309.0     743.4  
Net income (loss)
   
1,392.0
   
1,689.4
   
1,642.2
   
822.9
   
879.2
 
Net income per 1,000 shares (weighted average)(3)(7)
                     
- Basic
                     
Common shares
   
27.94
   
39.46
   
37.93
   
18.84
   
19.28
 
Preferred shares
   
30.74
   
43.41
   
41.72
   
20.71
   
21.20
 
- Diluted
                     
Common shares
   
27.79
   
39.05
   
37.65
   
18.59
   
18.55
 
Preferred shares
   
30.57
   
42.95
   
41.37
   
20.45
   
20.41
 
Net income (loss) per ADS(4)
                     
- Basic
                     
Common shares
   
2.79
   
3.95
   
3.79
   
1.88
   
1.93
 
Preferred shares
   
30.7
   
4.34
   
4.17
   
2.07
   
2.12
 
- Diluted
                     
Common shares
   
2.78
   
3.91
   
3.77
   
1.86
   
1.86
 
Preferred shares
   
3.06
   
4.30
   
4.14
   
2.05
   
2.04
 
Dividends and interest attributable to shareholders equity per 1,000 shares (weighted average)(3)(5) (6)
                     
- Basic
                     
Common shares
   
11.21
 
 
22.16
 
 
4.53
   
5.74
   
3.55
 
Preferred shares
   
12.33
 
 
24.38
   
4.99
   
6.31
   
3.90
 
- Diluted
   
   
   
   
   
 
Common shares
   
11.15
 
 
21.93
   
4.50
   
5.67
   
3.41
 
Preferred shares
   
12.26
 
 
24.12
   
4.94
   
6.23
   
3.76
 
Weighted average number of shares (thousands)(3)(7)(8)(20)
   
   
   
   
   
 
- Basic
   
   
   
   
   
 
Common shares
   
22,345,110
 
 
18,664,356
   
18,908,907
   
19,170,168
   
21,502,332
 
Preferred shares
   
24,970,421
   
21,952,196
   
22,173,258
   
22,291,121
   
21,919,724
 
- Diluted
   
   
   
   
   
 
Common shares
   
22,388,341
   
18,733,355
   
18,962,604
   
19,257,270
   
21,988,430
 
Preferred shares
   
25,186,577
   
22,299,692
   
22,441,743
   
22,726,632
   
23,090,525
 
 
 

 
3


BALANCE SHEET DATA
 

 
As of or for the year ended December 31,
         
2003
   
2002
   
2001
   
2000
 
 
(R$ in millions, except for per share amounts,
number of shares and other operating data) 
Brazilian GAAP                                 
                               
Balance Sheet Data:
                               
Cash, cash equivalents and short term investments
   
1,505.4
   
2,534.2
   
3,290.0
   
2,562.9
   
1,028.3
 
Total current assets
   
5,379.6
   
5,500.5
   
5,571.4
   
4,684.9
   
2,687.6
 
Prepaid pension benefit cost(12)
   
20.6
   
22.0
   
21.6
   
20.8
       
Investments
   
18,204.6
   
1,711.4
   
637.3
   
662.6
   
659.6
 
Property, plant and equipment,
net
   
5,531.7
   
4,166.3
   
3,330.6
   
3,277.7
   
3,204.3
 
Deferred income tax - non-current
   
2,216.6
   
1,831.8
   
1,558.4
   
1,160.3
   
996.1
 
Total assets
   
33,016.5
   
14,830.1
   
12,381.5
   
11,028.8
   
8,639.7
 
Short-term debt(9)
   
3,443.1
   
1,976.1
   
607.4
   
1,720.0
   
1,265.3
 
Total current liabilities
   
8,771.7
   
4,720.0
   
2,833.7
   
3,412.0
   
2,699.6
 
Long-term debt(10)
   
4,367.6
   
4,004.3
   
3,879.3
   
2,849.4
   
927.6
 
Accrued liability for
contingencies
   
1,471.0
   
1,232.9
   
989.3
   
815.5
   
878.0
 
Sales tax deferrals and other tax credits(11)
   
711.9
   
768.7
   
803.1
   
746.8
   
650.6
 
Post-retirement benefit(12) 
   
646.0
   
72.9
   
53.4
   
55.6
       
Total long-term liabilities
   
7,050.6
   
5,605.5
   
5,339.1
   
4,164.4
   
2,350.6
 
Minority interest
   
198.3
   
196.4
   
79.1
   
88.9
   
512.5
 
Subscribed and paid-up capital
   
4,742.8
   
3,124.1
   
3,046.2
   
2,944.3
   
2,565.2
 
Shareholders’ equity 
   
16,995.9
   
4,382.9
   
4,129.6
   
3,363.5
   
3,077.0
 
                                 
U.S. GAAP
                               
                                 
Total assets
   
29,659.5
   
13,766.0
   
11,584.6
   
10,195.9
   
7,743.0
 
Shareholders’ equity
   
17,720.3
   
4,382.9
   
3,960.6
   
2,839.9
   
2,378.2
 


4

 
 

OTHER DATA
 
 
As of or for the year ended December 31, 
         
2003
   
2002
   
2001
   
2000
 
 
 
(R$ in millions, except for per share amounts,
number of shares and other operating data) 
Brazilian GAAP                                
                                 
Other Financial Information:
                               
                                 
Net working capital(13)
   
(3,392.1
)
 
780.5
   
2,737.7
   
1,273.0
   
(12.0
)
Cash dividends paid(5)
   
602.9
   
1,026.9
   
335.6
   
313.4
   
221.1
 
Depreciation and amortization of deferred charges (14)
   
922.2
   
766.3
   
659.5
   
613.9
   
589.2
 
Capital expenditures(15)
   
1,273.7
   
862.2
   
544.7
   
446.8
   
295.0
 
Operating cash flows - generated(16)
   
3,418.6
   
2,527.6
   
3,595.0
   
1,006.6
   
1,243.2
 
Investing cash flows - used(16)
   
(110.8
)
 
(2,014.7
)
 
(1,603.1
)
 
(1,687.4
)
 
(100.7
)
Financing cash flows-generated - used(16)
   
(3,433.9
)
 
(346.7
)
 
(2,912.2
)
 
1,418.0
   
(2,065.7
)
                                 
                                 
Other Operating Data:
                               
                                 
Total production capacity - beer(17)
   
114.2 million hl
 
 
88.3 million hl
   
89.7 million hl
   
89.8 million hl
   
94.4 million hl
 
Total production capacity - CSD & NANC(17)
   
43.9 million hl
 
 
45.7 million hl
   
37.3 million hl
   
38.8 million hl
   
36.6 million hl
 
Total beer volume sold(18)
   
63.9 million hl
 
 
56.9 million hl
   
62.0 million hl
   
62.4 million hl
   
64.8 million hl
 
Total CSD & NANC volume sold(18)
   
22.8 million hl
 
 
19.2 million hl
   
19.6 million hl
   
18.5 million hl
   
17.2 million hl
 
Number of employees(19)
   
25,974
 
 
18,890
   
18,570
   
18,136
   
18,172
 

 
5

 
 
Footnotes to selected financial information
(1) General and administrative expenses include director’s fees.
 
(2)   Operating income under Brazilian GAAP is presented after financial income and financial expense.
 
(3)   The information is provided per thousand shares because AmBev common and preferred shares are generally traded on the São Paulo Stock Exchange in blocks of one thousand shares.
(4) ADS represents American Depositary Shares. Each ADS represents 100 shares.
 
(5)    Includes dividends, interest attributable to shareholders’ equity (including withholding tax paid by AmBev in respect thereof), and in 2000, returns of capital of R$111.8 million. Certain distributions in 2000 were made in the form of a return of capital rather than in the form of dividends or interest attributable to shareholders’ equity because, prior to the completion of the Brahma conversion, AmBev did not have sufficient retained earnings to pay these amounts as dividends or interest attributable to shareholders’ equity. The dividend and interest attributable to shareholders equity per 1,000 shares for Brazilian GAAP purposes is calculated net of withholding tax and therefore represents the amounts received as disclosed in “Dividends”. We changed the criteria for reporting this amount in 2002 and therefore the dividends per share disclosed in the years prior to 2002 do not conform to those disclosed in our 2001 annual report on Form 20-F.
 
(6)    Brazilian GAAP and U.S. GAAP differ on the recognition of declared / proposed dividends, specifically with regard to when the dividend should be recognized. The executive officers are required to propose a dividend at year end, which is subject to ratification by the shareholders at a general meeting and must be recognized under Brazilian GAAP. However, under U.S. GAAP, the proposed dividends may be modified or ratified by the shareholders at a general meeting and are treated as a deduction from shareholders’ equity.
 
(7)    In the U.S. GAAP selected financial data only, earnings per share are calculated dividing the net income by the weighted average number of common and preferred shares outstanding during the relevant periods. In the Brazilian GAAP selected financial information section, earnings per share are calculated by dividing by the number of shares outstanding at the year end. AmBev’s preferred shares are entitled to dividends 10% greater than the dividends paid to common shares.
 
(8)   Under U.S. GAAP we have included the net assets of the FAHZ, one of our major shareholders, on our balance sheet as of December 31, 2004, 2003, 2002, 2001 and 2000. As a result, AmBev shares owned by the FAHZ are treated as treasury shares, rather than outstanding shares, thereby reducing the number of our weighted average outstanding shares and increasing our earnings or loss per share. For further information, please refer to our consolidated financial statements contained within this annual report.
 
(9)    Includes current portion of long-term debt.
 
(10)   Excludes current portion of long-term debt.
 
(11)  In the financial statements as of and for the year ended December 31, 2004, total tax incentives are R$711.9 million, of which 381.6 million relate to deferred sales tax, and R$381.6 million to ICMS financing incentives.
 
(12)  Consistent with accounting practice under Brazilian GAAP, we had not recognized our actuarial obligation for pension liabilities and post-retirement benefits, including medical benefits to retirees in our financial statements prior to December 31, 2001. Pension amounts due to the pension plan were treated on an accrual basis as the obligations fell due. However, following the issuance of accounting standard NPC No. 26, we are required to record these actuarial obligations beginning in 2002. We had the option to account for these actuarial obligations at December 31, 2001 either against retained earnings or prospectively as a charge against earnings over five years. We elected to recognize the liability against retained earnings on December 31, 2001. The standard requires comprehensive recording of pension expenses and obligations on an actuarial basis instead of, as was previously required, based on the required contributions for the relevant year.
 
(13)  Represents total current assets less total current liabilities.
 
(14)  Includes depreciation of property, plant and equipment and amortization of deferred charges.
 
(15)  Represents cash expenditures for property, plant and equipment.
 
(16) Operating, Investing and Financing cash flows data is derived from our consolidated financial statements.
 
(17)  Represents available production capacity of AmBev and its respective subsidiaries, domestic and international; Quinsa’s production capacity is not considered; (hl is the abbreviation for hectoliters; CSD & NANC is the abbreviation for Carbonated Soft Drinks and Non Alcoholic and Non Carbonated Soft Drinks).
 
(18)  Represents full-year volumes of AmBev and its respective subsidiaries (except Quinsa and its subsidiaries).  Labatt's volumes for 2004 were consolidated from August 27 through December 31.
 
(19)  Includes all production- and non-production-related employees of AmBev and its respective subsidiaries, excluding Quinsa and its subsidiaries.
 
       (20)  In the U.S.  GAAP selected financial data only, earnings per share have been restated to give retroactive effect to the share dividend distributed by AmBev on May 31, 2005.


6


DIVIDENDS
 
Dividend Policy
 
AmBev intends to pay dividends twice a year to its shareholders; however, the timing and amount of future dividend payments, if any, will depend upon various factors the Board of Directors of AmBev considers relevant, including the earnings and the financial condition of AmBev. AmBev’s bylaws provide for a mandatory dividend of 35% of its annual net income, if any, as determined and adjusted under Brazilian GAAP (“adjusted income”). The mandatory dividend includes amounts paid as interest attributable to shareholders’ equity, which is equivalent to a dividend but is a more tax efficient way to distribute earnings because they are generally deductible by the company for Brazilian income tax purposes. However, shareholders (including holders of ADSs) have to pay Brazilian withholding tax on the amounts received as interest attributable to shareholders’ equity, whereas no such payment is required in connection with dividends received. Although AmBev may distribute earnings in the form of interest, the amount received by shareholders is the same as or higher than if the distribution were made in the form of dividends. Withholding tax is usually paid by Brazilian companies, including AmBev, on behalf of their shareholders.
 
Adjusted income may be capitalized, used to absorb losses or otherwise appropriated as allowed under Brazilian Corporate Law; therefore, any adjusted income may no longer be available to be paid as dividends. AmBev may also not pay dividends to its shareholders in any particular fiscal year, upon the determination by the Board of Directors that such distributions would be inadvisable in view of AmBev’s financial condition. Any such dividends not distributed would be allocated to a special reserve account for future payment to shareholders, unless it is used to offset subsequent losses. For further information on this matter see “—Risk Factors—Risks Relating to our Securities—AmBev shareholders may not receive any dividends”. Any dividends payable on AmBev’s preferred shares must be 10% greater than those payable on AmBev’s common shares. See “Additional Information—Memorandum and Articles of Association—Dividends and Reserves—Dividend Preference of Preferred Shares”.
 
For further information on Brazilian Corporate Law provisions relating to required reserves and payment of dividends or interest attributable to shareholders’ equity, as well as specific rules applicable to the payment of dividends by AmBev, see “Additional Information—Memorandum and Articles of Association—Dividends and Reserves”.
 
AmBev - Dividends and Interest Attributable to Shareholders’ Equity
 
The following table shows the cash dividends paid by AmBev’s predecessor Brahma, to its preferred and common shareholders from 1999 through September 15, 2000, and by AmBev to its preferred and common shareholders since September 15, 2000 in Reais and in U.S. dollars translated from Brazilian Reais at the commercial exchange rate as of the date of payment. The amounts include interest attributable to shareholders’ equity, net of withholding tax, and return of capital. See “Additional Information—Memorandum and Articles of Association—Dividends and Reserves—Interest Attributable to Shareholders’ Equity”. In addition, on May 31, 2005, AmBev distributed a share dividend to each shareholder of AmBev at a rate of one AmBev common share for every five preferred and/or common shares held by such shareholder at that date. See “Information on the Company—History and Development of the Company”.
 

7



Earnings generated
   
First payment date
   
Reais per
thousand(1) share(2)
 
U.S. dollar equivalent per
thousand(1) shares at payment date(4)
                           
First half 1999
       
1.58
   
(preferred
)
 
0.88
 
           
1.44
   
(common
)
 
0.80
 
Second half 1999
       
2.96
   
(preferred
)
 
1.70
 
           
2.69
   
(common
)
 
1.54
 
Extraordinary(3)
       
1.88
   
(preferred
)
 
1.09
 
           
1.88
   
(common
)
 
1.09
 
Extraordinary(3)
       
2.38
   
(preferred
)
 
1.22
 
           
2.38
   
(common
)
 
1.22
 
Second half 2000
       
4.11
   
(preferred
)
 
2.05
 
           
3.74
   
(common
)
 
1.86
 
First half 2001
       
3.11
   
(preferred
)
 
1.16
 
           
2.83
   
(common
)
 
1.06
 
Second half 2001
       
4.78
   
(preferred
)
 
1.97
 
           
4.34
   
(common
)
 
1.79
 
First half 2002
       
4.37
   
(preferred
)
 
1.15
 
           
3.97
   
(common
)
 
1.04
 
Second half 2002
       
9.27
   
(preferred
)
 
2.60
 
           
8.43
   
(common
)
 
2.37
 
First half 2003
       
18.70
   
(preferred
)
 
6.59
 
           
17.00
   
(common
)
 
5.99
 
Second half 2003
       
6.75
   
(preferred
)
 
2.30
 
           
6.14
   
(common
)
 
2.09
 
First half 2004
       
5.80
   
(preferred
)
 
2.05
 
           
5.28
   
(common
)
 
1.87
 
Second half 2004
       
17.15
   
(preferred
)
 
6.66
 
           
15.59
   
(common
)
 
6.05
 
 
(1) The information is provided per thousand shares because AmBev common and preferred shares are generally traded on the São Paulo Stock Exchange in blocks of one thousand.
(2) The amounts set forth above are amounts actually received (as adjusted to give effect retroactively to AmBev’s common and preferred share five-for-one stock split effective October 23, 2000) by shareholders, which are net of withholding tax. The amounts set forth here represent pro-forma U.S. GAAP calculations for the impact of a stock split which is not required under Brazilian GAAP. The financial statements present the amounts actually disbursed, including the withholding tax on interest on shareholders’ equity, which was paid on behalf of AmBev’s shareholders. The dividends per thousand shares set forth above are calculated based on the number of shares outstanding at the date the distributions were declared (as adjusted to give effect retroactively to AmBev’s common and preferred share five-for-one stock split effective October 23, 2000).
(3) On March 23, 2000 and on November 30, 2000 AmBev distributed R$1.88 (U.S. $1.09) per common and preferred shares and R$2.38 (U.S. $1.22) per common and preferred shares, respectively, to its shareholders as a return of capital.
(4) Translated to U.S. dollars at the exchange rate in effect at the date declared.


8


EXCHANGE RATE INFORMATION
 
There were previously two foreign exchange markets in Brazil. With the enactment of National Monetary Council Resolution No. 3,265 of March 14, 2005, the foreign exchange markets were consolidated to form one exchange market. All transactions involving foreign currency in the Brazilian market, whether carried out by investors resident or domiciled in Brazil or investors resident or domiciled abroad, must now be conducted on this exchange market, through institutions authorized by the Central Bank, subject to the rules of the Central Bank.
 
The following tables set forth commercial market rates for the purchase of U.S. dollars for the periods indicated. Foreign exchange transactions were carried out on either the commercial rate exchange market or the floating rate exchange market. Rates in the two markets were generally the same. The table uses the commercial selling rate prior to March 14, 2005.
 
 
 
Annual Exchange Rates of Reais per U.S.$1.00 
     
2004
   
2003
   
2002
   
2001
   
2000
 
                                 
Low
   
R$2.6544
   
R$2.8219
   
R$2.2709
   
R$1.9357
   
R$1.7234
 
High
   
3.2051
   
3.6623
   
3.9552
   
2.8007
   
1.9847
 
Average(1)
   
2.9257
   
3.0600
   
2.9983
   
2.3532
   
1.8348
 
Period End
   
2.6544
   
2.8892
   
3.5333
   
2.3204
   
1.9554
 

_______________
Source: Central Bank
 
(1) Represents the average of the month-end exchange rates during the relevant period.
 
 
Monthly Exchange Rates of Reais per U.S.$1.00 
   
2005
 
2004
 
 
   
May 
   
April
   
March
   
February
   
January
   
December
 
                                       
Low
   
R$2.3784
   
R$2.5195
   
R$2.6011
   
R$2.5621
   
R$2.6248
   
R$2.6544
 
High
   
2.5146
   
2.6598
   
2.7621
   
2.6320
   
2.7222
   
2.7867
 

_______________
Source: Central Bank
 
We will pay any cash dividends and make any other cash distributions in reais. Accordingly, exchange rate fluctuations may affect the U.S. dollar amounts received by the holders of ADSs on conversion by the depositary of such distributions into U.S. dollars for payment to holders of ADSs. Fluctuations in the exchange rate between the real and the U.S. dollar may also affect the U.S. dollar equivalent of real price of our shares on the São Paulo Stock Exchange. For further information on this matter see “Risk Factors—Risks Relating to Our Securities”.
 
EXCHANGE CONTROLS
 
There are no restrictions on ownership of the ADSs or the preferred or common shares by individuals or legal entities domiciled outside of Brazil.
 
The right to convert dividend payments, interest attributable to shareholders’ equity payments and proceeds from the sale of preferred or common shares into foreign currency and to remit such amounts outside Brazil is subject to exchange control restrictions and foreign investment legislation which generally requires, among other things, that relevant investments be registered with the Central Bank. Restrictions on the remittance of foreign capital abroad could hinder or prevent Banco Itaú S.A. (the “custodian”) or holders who have exchanged AmBev’s ADSs for shares of AmBev, from converting dividend distributions, interest on shareholders’ equity or the proceeds from any sale of shares of AmBev into U.S. dollars and remitting such U.S. dollars abroad. Holders of AmBev ADSs could be adversely affected by delays in or refusal to grant any required governmental approval for conversions of real payments and remittances abroad.
 
Under Brazilian law relating to foreign investment in the Brazilian capital markets (“Foreign Investment Regulations”), foreign investors registered with the CVM and acting through authorized custody accounts managed
 
 
9

 
 
by local agents may buy and sell shares on Brazilian stock exchanges without obtaining separate certificates of registration for each transaction. Foreign investors may register their investment under Law 4,131/62 or Resolution No. 2,689/00 of the National Monetary Council (“Resolution No. 2,689”).
 
Under Resolution No. 2,689, foreign investors may invest in almost all financial assets and engage in almost all transactions available in the Brazilian financial and capital markets, provided that certain requirements are fulfilled. In accordance with Resolution No. 2,689, the definition of a foreign investor includes individuals, legal entities, mutual funds and other collective investment entities, domiciled or headquartered abroad.
 
Securities and other financial assets held by a Resolution No. 2,689 investor must be registered or maintained in deposit accounts or under the custody of an entity duly licensed by the Central Bank or the CVM. In addition, any transfer of securities held under Resolution No. 2,689 must be carried out in the stock exchanges or through organized over-the-counter markets licensed by the CVM, except for specific types of transfers.
 
Under current legislation, the Brazilian government may impose temporary restrictions on remittances of foreign capital abroad in the event of a serious imbalance or an anticipated serious imbalance of Brazil’s balance of payments. For approximately six months in 1989 and early 1990, the Brazilian government froze all dividend and capital repatriations held by the Central Bank that were owed to foreign equity investors in order to conserve Brazil’s foreign currency reserves. These amounts were subsequently released in accordance with Brazilian government directives. We cannot assure you that the Brazilian government will not impose similar restrictions on foreign repatriations in the future. See “Risk Factors—Risks Relating to Brazil and Other Countries in Which We Operate” and “Risk Factors—Risks Relating to Our Securities Controls and restrictions on foreign currency remittance could harm the ability of AmBev to transfer dividend payments off-shore”. The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. Brazilian economic and political conditions have a direct impact on our business.
 
Pursuant to the registration obtained by AmBev with the Central Bank in the name of the Bank of New York with respect to the AmBev ADSs to be maintained by the custodian, Banco Itaú S.A., on behalf of the Bank of New York, the custodian and The Bank of New York will be able to convert dividends and other distributions with respect to the AmBev shares represented by AmBev ADSs into foreign currency and remit the proceeds outside of Brazil. In the event that a holder of AmBev ADSs exchanges such ADSs for AmBev shares such holder will be entitled to continue to rely on The Bank of New York’s registration for only five business days after such exchange, after which such holder must obtain its own registration. Any such holder may not be able to obtain and remit abroad U.S. dollars or other hard currencies upon the disposition of the shares or distributions with respect to such disposition, unless such holder qualifies under the Foreign Investment Regulations or obtains its own registration, and such holder generally will be subject to less favorable Brazilian tax treatment than a holder of AmBev ADSs. For further information on this matter see “Additional Information—Taxation—Brazilian Tax Considerations”.
 

10


Risk Factors
 
Before making an investment decision, you should consider all of the information set forth in this annual report. In particular, you should consider the special features applicable to an investment in Brazil and applicable to an investment in AmBev, including those set forth below. In general, investing in the securities of issuers in emerging market countries, such as Brazil, involves a higher degree of risk than investing in the securities of issuers in the United States.
 
For purposes of this section, when we state that a risk, uncertainty or problem may, could or would have an “adverse effect” on us, we mean that the risk, uncertainty or problem may, could or would have an adverse effect on our business, financial condition, liquidity, results of our operations or prospects, except as otherwise indicated or as the context may otherwise require. You should view similar expressions in this section as having a similar meaning.
 
RISKS RELATING TO BRAZIL AND OTHER COUNTRIES IN WHICH WE OPERATE
 
Economic uncertainty and volatility in Brazil may adversely affect our business
 
Our most significant market is Brazil, which has periodically experienced extremely high rates of inflation. Inflation, along with governmental measures to combat inflation and public speculation about possible future measures, has had significant negative effects on the Brazilian economy. The annual rates of inflation, as measured by the National Consumer Price Index (Índice Nacional de Preços ao Consumidor), have reached in the not-so-distant past a hyper-inflationary peak of 2,489.1% in 1993. Brazilian inflation, as measured by the same index, was 14.7% in 2002, 10.4% in 2003, and 6.1% in 2004.
 
Brazil may experience high levels of inflation in the future. There can be no assurance that recent lower levels of inflation will continue. Future governmental actions, including actions to adjust the value of the real, may trigger increases in inflation. We cannot assure you that inflation will not affect our business in the future. In addition, the Brazilian government’s actions to maintain economic stability, as well as public speculation about possible future actions, may contribute significantly to economic uncertainty in Brazil and may heighten volatility in the Brazilian securities markets and securities issued abroad by Brazilian issuers.
 
The Brazilian currency has devalued constantly during the last four decades. Throughout this period, the Brazilian government has implemented various economic plans and utilized a number of exchange rate policies, including sudden devaluations and periodic mini-devaluations, during which the frequency of adjustments has ranged from daily to monthly, floating exchange rate systems, exchange controls and dual exchange rate markets. There have been significant fluctuations in the exchange rates between Brazilian currency and the U.S. dollar and other currencies. For example, the U.S. dollar / real exchange rate depreciated from R$2.3204 per U.S.$1.00 at December 31, 2001 to R$3.5333 at December 31, 2002. The exchange rate reached R$3.9552 per U.S.$1.00 in October 2002. However, the stability established by the economic policy initiated by the government has restored some confidence in the market. This resulted in an appreciation of the real in 2003 of 22.3%, resulting in an exchange rate of R$2.8892 per U.S.$1.00 as of December 31, 2003, and a further 8.8% appreciation in 2004, resulting in an exchange rate of R$2.6544 per U.S.$1.00 as of December 31, 2004.
 
Devaluation of the real relative to the U.S. dollar would create additional inflationary pressures in Brazil by generally increasing the price of imported products and requiring recessionary governmental policies to curb aggregate demand. On the other hand, appreciation of the real against the U.S. dollar may lead to a deterioration of the current account and the balance of payments, as well as dampen export-driven growth. The potential impact of the floating exchange rate and measures of the Brazilian government aimed at stabilizing the real is uncertain. In addition, a substantial increase in inflation may weaken investor confidence in Brazil, impacting our ability to finance our operations through the international capital markets.
 
Devaluation of the real relative the U.S. dollar may adversely affect our financial performance
 
Most of our sales are in reais; however, a significant portion of our debt is denominated in or indexed to U.S. dollars. In addition, a significant portion of our operating expenses, in particular those related to packaging such as aluminum and iron cans and PET bottles, as well as hops and malt are also denominated in or linked to U.S. dollars. Therefore, the devaluation of the real increases our financial expenses and operating costs and could affect
 
11

 
our ability to meet our foreign currency obligations. Although in the last two years the real has appreciated against the U.S. dollar, we cannot assure you that it will continue to do so in the future. Our current policy is to hedge substantially all of our U.S. dollar-denominated debt against adverse changes in foreign exchange rates; however, we cannot assure you that such hedging will be possible at all times in the future.
 
Increases in taxes levied on beverage products in Brazil and high levels of tax evasion may adversely affect our results and profitability
 
Increases in Brazil’s already high levels of taxation could adversely affect our profitability. Increases in taxes on beverage products usually result in higher beverage prices for consumers. Higher beverage prices generally result in lower levels of consumption and, therefore, lower net sales. Lower net sales result in lower margins because some of our costs are fixed and thus do not vary significantly based on the level of production. We cannot assure you that the government will not increase current tax levels, at both state and/or federal levels, and that this will not impact our business.
 
In addition, the Brazilian beverage industry experiences high levels of tax evasion, which is primarily due to the high level of taxes on beverage products in Brazil. An increase in taxes may lead to an increase in tax evasion, which could result in unfair pricing practices in the industry. We have proposed to the federal government regulation requiring the mandatory installation of flow meters in all Brazilian beer and soft drinks factories in order to help the federal and state governments fight tax evasion in the beverage industry. The federal government issued this regulation in 2004 with respect to the beer industry only and is expected to enact similar regulations with respect to the carbonated soft-drinks industry by the end of 2005. We cannot assure you that such regulation will be enacted and have the impact we expect. Moreover, if such regulation is not enacted we cannot assure you that our business and results of operations will not be further impacted.
 
Quinsa is subject to substantial risks relating to its business and operations in Argentina and other countries in which it operates
 
On January 31, 2003, we acquired a significant interest in Quinsa. Quinsa is a brewing company with a substantial portion of its operations in Argentina and other South American countries. As a result, Quinsa’s financial conditions and results of operations may be adversely affected by Argentine and other countries in which it operates’ political instability, fluctuations in the economy and governmental actions concerning the economy. For example, Argentina has recently experienced political and economic instability. Commercial and financial activities were virtually paralyzed in 2002, further aggravating the economic recession that precipitated the above-mentioned crisis. A widespread recession followed in 2002, including a 10.9% decrease in real GDP, high unemployment and high inflation, which have led to a reduction of disposable income and of wages in real terms and resulted in changes in consumer behavior across all class sectors of the Argentine population. Argentina began to stabilize in 2003 and continued to exhibit signs of stability in 2004, with real GDP growth at 9.0% for the year, stable inflation and peso nominal exchange rate during 2004, with variations of 6.1% and 1.7%, respectively. There was also improvement in the employment situation. The unemployment rate reached 12.1% during the fourth quarter of 2004, a decrease of 26% from the levels it had reached during the 2002 to 2003 period.
 
Notwithstanding the current continued stabilization, the Argentine economic and social situation have quickly deteriorated in the past, and may quickly deteriorate in the future, and we cannot assure you that the Argentine economy will continue its sustained growth. The devaluation of the Argentine peso and the macroeconomic conditions prevailing in Argentina could have, and may continue to have, a material adverse effect on Quinsa’s, and indirectly on our, results of operations.
 
U.S. investors may not be able to effect service of process upon, or to enforce judgments against us
 
We are organized under the laws of the Federative Republic of Brazil. Substantially all of our directors and executive officers and the experts named in this annual report are residents of countries other than the United States. All or a substantial portion of the assets of such non-U.S. residents and of AmBev are located outside the United States. As a result, it may not be possible for investors to effect service of process within the United States upon such persons or AmBev, or to enforce against them in U.S. courts judgments obtained in such courts based upon civil liability provisions of the Federal securities laws of the United States or otherwise.
 
 
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Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy; Brazilian economic and political conditions have a direct impact on our business
 
The Brazilian economy has been characterized by significant involvement on the part of the Brazilian government, which often changes monetary, credit and other policies to influence Brazil’s economy. The Brazilian government’s actions to control inflation and affect other policies have often involved wage and price controls, the Central Bank’s base interest rates, as well as other measures, such as the freezing of bank accounts, which occurred in 1990.
 
Actions taken by the Brazilian government concerning the economy may have important effects on Brazilian corporations and other entities, including AmBev, and on market conditions and prices of Brazilian securities. Our financial condition and results of operations may be adversely affected by the following factors and the Brazilian government’s response to the following factors:
 
·  
devaluations and other exchange rate movements;
 
·  
inflation;
 
·  
exchange control policies;
 
·  
social instability;
 
·  
price instability;
 
·  
energy shortages;
 
·  
interest rates;
 
·  
liquidity of domestic capital and lending markets;
 
·  
tax policy; and
 
·  
other political, diplomatic, social and economic developments in or affecting Brazil.
 
Changes in Brazilian Labor Laws may affect us
 
Brazilian companies are subject not only to the Federal Constitution and ordinary legislation concerning labor relations (mainly the Consolidação das Leis do Trabalho, or “CLT”), but also to collective bargaining agreements between employers’ associations and employees unions or between individual employers’ and employee unions, in addition to administrative orders and instructions issued by the Brazilian Labor Department.
 
In April 2003, the Lower House reopened the discussions regarding amendments to the CLT. As part of these discussions, a number of amendments have been proposed, including modifications to the role of labor unions in Brazil. These amendments already in discussion or any future proposed amendment, may, if implemented, increase the powers of centrais sindicais (reunions of labor unions) to represent categories of our employees, thereby increasing their negotiating leverage. This, in turn, could significantly affect our business in the future.
 
RISKS RELATING TO AMBEV
 
We are subject to Brazilian and other antitrust regulations
 
We have a substantial beer market share in Brazil and thus are subject to regulation under Brazilian antitrust rules. In addition, in connection with the combination of Brahma and Antarctica, we entered into a performance agreement with the Brazilian antitrust authorities, pursuant to which we are subject to certain continuing restrictions over our distribution network. For further information on this matter see “Financial Information—Consolidated Financial Statements and Other Financial Information—Legal Proceedings—Antitrust matters”. We are also party to other antitrust legal proceedings. For further information on this matter see “Financial
 
 
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Information—Consolidated Financial Statements and Other Financial Information—Legal Proceedings—Antitrust matters”. We cannot assure you that Brazilian antitrust regulation will not affect our business in the future.
 
AmBev’s participation in the Argentine beer market increased substantially after the acquisition of our interest in Quinsa. Quinsa is subject to regulation under Argentinean antitrust rules. In addition, AmBev and Quinsa must comply with the conditions established by the CNDC, in connection with the acquisition of our interest in Quinsa. For further information on this matter see “Information on the Company—AmBev Business Overview—Acquisition of interest in Quinsa”. We cannot assure you that Argentinean antitrust regulation will not affect Quinsa’s business in the future, and therefore, impact the benefits that AmBev anticipates will be generated from this investment.
 
We are subject to regulation on alcoholic beverages in the countries in which we operate
 
Our business is regulated by federal, state, provincial and local laws and regulations regarding such matters as licensing requirements and marketing practices and related matters. Recently, certain Brazilian states and municipalities in which we operate have enacted legislation restricting the hours of operations of certain points of sale, imposing seals on beverage cans, prohibiting the sale of alcoholic beverages on highway points of sale and prohibiting the sale of soft drinks in schools. In addition, the Brazilian Congress is evaluating proposed regulation on the consumption, sales and marketing of alcoholic beverages, including beer which, if enacted, may impose restrictions on the advertisement of alcoholic beverage products on television during specified times of the day and the hours of operation of certain points of sale, among other things.
 
These restrictions may adversely impact our results of operations. For further information, please refer to “Information on the Company—AmBev Business Overview—Regulation—General.”
 
We are subject to more extensive regulations in Canada than in the other countries in which we operate
 
Our North America operations are subject to more extensive regulations than our other operations, which may cause us to face unexpected challenges. We cannot assure you that problems encountered while dealing with these future changes in the regulatory environment will not have a material adverse effect on our business, financial condition and results of operation in North America.
 
There may be unforeseen costs and difficulties associated with the integration of Labatt
 
While we have identified certain potential synergies and cost savings that we believe may be realizable following the completion of the integration of Labatt, there can be no assurance that such potential synergies and cost savings will be realized in the near future, if at all. Labatt operates in a market and geographic region that has different characteristics from the markets and regions in which we have historically operated, and as a result, we may encounter unexpected challenges and problems in the management and operation of the Labatt business. Accordingly, there can be no assurance that substantial expenses and delays will not be incurred in the course of the integration. The process of coordinating and integrating the acquisition could interrupt or interfere with the ordinary operations of the businesses. Any major difficulties encountered in the integration of the businesses could have a material adverse effect on our business, financial condition and results of operation.
 
RISKS RELATING TO OUR SECURITIES
 
The relative volatility and illiquidity of securities of Brazilian companies may substantially limit your ability to sell our securities at the price and time you desire
 
Investing in securities of companies in emerging markets, such as Brazil, involves greater risk than investing in securities of companies from more developed countries and such investments are generally considered speculative in nature.
 
Brazilian investments, such as investments in our securities, are subject to economic and political risks, involving, among others:
 
·  
changes in the regulatory, tax, economic and political environment that may affect the ability of investors to receive payment, in whole or in part, in respect of their investments; and
 
·  
restrictions on foreign investment and on repatriation of capital invested.
 
The Brazilian securities markets are substantially smaller, less liquid, more concentrated and more volatile than major U.S. and European securities markets, and are not as highly regulated or supervised as these markets. The relatively small market capitalization and illiquidity of the Brazilian securities markets may substantially limit your ability to sell the securities at the price and time you desire.
 
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Deterioration in economic and market conditions in other emerging market countries may adversely affect the market price of AmBev’s securities
 
Economic and market conditions in other emerging market countries, especially those in Latin America, influence the market for securities issued by Brazilian companies and investors’ perception of economic conditions in Brazil. Past economic crisis in emerging markets, such as in Southeast Asia, Russia and Argentina, triggered securities market volatility in Brazil and other emerging market countries’ securities markets. Recently, Argentina, Venezuela, Uruguay and Paraguay have experienced a significant economic downturn. The market value of our securities may therefore be adversely affected by events occurring outside of Brazil, especially in other emerging market countries.
 
Our controlling shareholders are able to determine the outcome of many corporate actions without the approval of non-controlling shareholders
 
The controlling shareholders of AmBev, InBev Holding Brasil S.A., formerly Braco Investimentos S.A. (“InBev Brasil”), and Fundação Antonio e Helena Zerrenner Instituição Nacional de Beneficência (FAHZ), together hold approximately 86.5% of AmBev’s common shares. In addition, BRC, which is controlled by Messrs. Lemann, Sicupira and Telles, is a party to the InBev Shareholders’ Agreement with respect to 321,712,000 ordinary shares of InBev, which represent approximately 52.9% of the outstanding capital stock of InBev.
 
InBev holds, directly or indirectly, including through its indirect ownership interests in InBev Brasil, shares of AmBev common stock that represent approximately 72.97% of the total voting power of AmBev’s capital stock. InBev thus has significant influence over AmBev, even though (i) InBev Brasil remains subject to the AmBev shareholders’ agreement with FAHZ and (ii) InBev is jointly controlled by its current controlling shareholders and Messrs. Lemann, Sicupira and Telles. For further information on these matters see “Background on the Company—InBev—AmBev Transactions” and “Major Shareholders and Related Party Transactions—Major Shareholders—AmBev Shareholders’ Agreement”.
 
The controlling shareholders are able to elect the majority of the members of the Board of Directors of AmBev and generally determine the outcome of other actions requiring the approval of AmBev’s shareholders. Under Brazilian Corporate Law, the protections afforded to non-controlling security holders and the fiduciary duties of directors may, in some respects, be less comprehensive than in the United States or other jurisdictions.
 
AmBev shareholders may not receive any dividends
 
According to its current bylaws, AmBev must generally pay its shareholders 35.0% of its annual net income, as determined and adjusted under Brazilian GAAP (“adjusted income”). The main sources for these dividends are AmBev’s operations and AmBev’s operating subsidiaries. Adjusted income may be capitalized, used to absorb losses or otherwise appropriated as allowed under Brazilian GAAP; therefore, adjusted income may not be available to be paid as dividends in a certain year. AmBev might not pay dividends to its shareholders in any particular fiscal year, upon the determination of the Board of Directors that such distributions would be inadvisable in view of AmBev’s financial condition. While the law does not establish the circumstances rendering the payment of dividends inadvisable, it is generally agreed that a company need not pay dividends if such payment threatens the existence of the company as a going concern or harms its normal course of operations.
  
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It is possible, therefore, that shareholders of AmBev will not receive dividends in any particular fiscal year. Any dividends not distributed would be allocated to a special reserve account for future payment to shareholders, unless it is used to offset subsequent losses.
 
Controls and restrictions on foreign currency remittance could harm the ability of AmBev to transfer dividend payments off-shore
 
Brazilian law provides that whenever there is a serious imbalance in Brazil’s balance of payments or reasons to foresee a serious imbalance, the Brazilian government may impose temporary restrictions on the remittance to foreign investors of the proceeds of their investments in Brazil. For example, for approximately six months in 1989 and early 1990 the Brazilian government froze all dividend and capital repatriations that were owed to foreign equity investors and held by the Central Bank in order to conserve Brazil’s foreign currency reserves. These amounts were subsequently released in accordance with Brazilian government directives. Similar measures could be taken by the Brazilian government in the future.
 
As a result, the Brazilian government may in the future restrict companies such as AmBev from paying amounts denominated in foreign currencies or require that any such payments be made in Brazilian reais. The likelihood that the Brazilian government would impose such restrictions may be affected by the extent of Brazil’s foreign currency reserves, the availability of foreign currency in the foreign exchange markets on the date a payment is due, the size of Brazil’s debt service burden relative to the economy as a whole, Brazil’s policy toward the International Monetary Fund and other factors. We cannot assure you that the Central Bank will not modify its policies or that the Brazilian government will not institute restrictions or delays on payments by Brazilians issuers in respect of securities issued in the international capital markets to date. For further information on this matter see “—Exchange Controls”.
 
If you exchange the AmBev ADSs for AmBev shares, you risk losing some foreign currency remittance and Brazilian tax advantages
 
The AmBev ADSs benefit from the foreign capital registration that The Bank of New York (as depositary) has in Brazil, which permits The Bank of New York to convert dividends and other distributions with respect to the AmBev shares into foreign currency and remit the proceeds abroad. If you exchange your AmBev ADSs for AmBev shares, you will be entitled to rely on The Bank of New York’s foreign capital registration for only five business days from the date of exchange. After this five-day period, you will not be able to remit abroad non-Brazilian currency unless you obtain your own foreign capital registration. In addition, gains with respect to AmBev shares will be subject to less favorable tax treatment unless you obtain your own certificate of foreign capital registration or you obtain your own registration with the Central Bank of Brazil pursuant to Resolution No. 2,689/00 of the National Monetary Council. For a more complete description of Brazilian restrictions on foreign investments and the foreign investment regulations, see “Additional Information—Memorandum and Articles of Association—Restrictions on Foreign Investment” and “—Exchange Controls”. For a more complete description of Brazilian tax regulations, see “Additional Information—Taxation—Brazilian Tax Considerations”.
 
AmBev ADSs have fewer and less well defined shareholders’ rights as compared to shareholders’ rights of similar U.S. companies
 
AmBev’s corporate affairs are governed by AmBev’s bylaws and Brazilian Corporate Law, which may differ from the legal principles that would apply to AmBev if the company were incorporated in a jurisdiction in the United States, such as Delaware or New York, or in other jurisdictions outside of Brazil. In addition, your rights or the rights of holders of the AmBev shares and ADSs under Brazilian Corporate Law to protect your interests relative to actions taken by AmBev’s Board of Directors or controlling shareholders may be fewer and less well-defined than under the laws of those other jurisdictions outside of Brazil.
 
Although Brazilian law imposes restrictions on insider trading and price manipulation, the Brazilian securities markets may not be as highly regulated and supervised as the U.S. securities markets or markets in other jurisdictions. In addition, rules and policies against self-dealing and regarding the preservation of shareholder interests may be less well-defined and enforced in Brazil than in the United States, potentially causing disadvantages to holders of the AmBev shares and ADSs. Corporate disclosures may be less complete or informative than what may be expected of a U.S. public company.
 
 
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Some entitlements are not available to U.S. holders of AmBev shares and ADSs
 
Due to various Brazilian and United States laws and regulations, United States holders of AmBev shares or ADSs may not be entitled to all of the rights possessed by Brazilian holders of AmBev shares. For instance, U.S. holders of AmBev shares may not be able to exercise any preemptive or preferential rights relating to their shares unless a registration statement under the Securities Act is effective with respect to such rights or an exemption from the registration requirements thereunder is available.
 

RISKS RELATING TO THE NOTES
 
Possible extension of the expected maturity of the notes
 
Under the terms of the notes and the indenture, if, on the expected maturity date for the notes, the insurance policy is in effect or certain funds are on deposit in the reserve account and certain specified events have occurred and are continuing relating to the imposition of currency exchange controls in Brazil, the date for the repayment of the notes will automatically be extended until the earlier to occur of (i) twenty-four calendar months from the expected maturity date; (ii) the latest date for which funds are available in the reserve account or under the letter of credit and under the insurance policy to pay interest on the notes; or (iii) the thirtieth day after any such currency exchange control event has ended. Accordingly, you should not rely, in making your investment decision, on receiving repayment in full of the notes on the initial expected maturity date.
 
Any such extension of the expected maturity date could, depending on changes in the financial conditions of AmBev, ultimately affect the ability of the noteholders to receive all amounts due to them under such international notes and the related international indentures.
 
Judgments of Brazilian courts enforcing our obligations under the notes or the indenture would be payable only in reais
 
If proceedings were brought in Brazil seeking to enforce our obligations under the notes or the indenture, we would not be required to discharge our obligations in a currency other than reais. Under the Brazilian exchange control limitations, an obligation to pay amounts denominated in a currency other than Brazilian currency, which is payable in Brazil, may only be satisfied in Brazilian currency at the rate of exchange, as determined by the Central Bank, in effect on the date of payment.
 
Controls and restrictions on foreign currency remittance could impede our ability to make payments under the notes
 
Brazilian law provides that whenever there is a serious imbalance in Brazil’s balance of payments or reasons to foresee a serious imbalance, the Brazilian government may impose temporary restrictions on the remittance to foreign investors of the proceeds of their investments in Brazil. See “—Controls and restrictions on foreign currency remittance could harm the ability of AmBev to transfer dividend payments to off-shore investors”.
 
We cannot assure you that mechanisms for the transfer of reais and conversion into U.S. dollars will continue to be available at the time we are required to perform our obligations under the notes or that a more restrictive control policy, which could affect our ability to make payments under the notes in U.S. dollars, will not be instituted in the future. If such financial mechanisms are not available, we will have to rely on a special authorization from the Central Bank to make payments under the notes in U.S. dollars. We cannot assure you that any such Central Bank approval would be obtained or that such approval would be obtained on a timely basis.
 
In the event that no such additional authorizations are obtained or obtainable from the Central Bank for the payment by AmBev of amounts owed under the indenture or the notes, as the case may be, AmBev may be able to lawfully pay the amounts due under the notes through an international transfer of reais. Through the international transfer of reais mechanism, payments made in reais by AmBev will be deposited in non-resident accounts held by AmBev, which would then purchase U.S. dollars through the exchange market, as defined in “—Exchange Rate Information” and “—Exchange Controls”, and remit U.S. dollars to the relevant agent for payment of the notes. No assurance can be given that the international transfer of reais or the exchange market will remain legally or commercially available to Brazilian residents.
 
 
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Book-entry registration
 
Because transfers and pledges of global notes can be effected only through book entries at the Depositary Trust Company (“DTC”), the liquidity of any secondary market for global notes may be reduced to the extent that some investors are unwilling to hold notes in book-entry form in the name of a DTC participant. The ability to pledge global notes may be limited due to the lack of a physical certificate. Beneficial owners of global notes may, in certain cases, experience delay in the receipt of payments of principal and interest since such payments will be forwarded by the paying agent to DTC who will then forward payment to the respective DTC participants, who will thereafter forward payment directly, or indirectly through Euroclear or Clearstream, to beneficial owners of the global notes. In the event of the insolvency of DTC or of a DTC participant in whose name global notes are recorded, the ability of beneficial owners to obtain timely payment and (if the limits of applicable insurance coverage by the Securities Investor Protection Corporation are exceeded, or if such coverage is otherwise unavailable) ultimate payment of principal and interest on global notes may be impaired.
 
Subordination to certain statutory liabilities
 
Under Brazilian law, our obligations under the notes and the indenture are subordinated to certain statutory preferences. In the event of our bankruptcy, and according to the new Brazilian bankruptcy law which became effective on June 9, 2005, such statutory preferences, such as claims for salaries and wages (up to 150 minimum wages, per plaintiff), social security and other taxes, court fees and expenses, will have preference over any other claims, including claims by any investor in respect of the notes.
 
Possible voluntary cancellation of the insurance policy and the letter of credit and refunding of amounts on deposit in the reserve account
 
Subject to certain conditions precedent relating to the rating of the notes, AmBev may request the trustee to cancel the insurance policy, refund all amounts on deposit in the reserve account and allow the letter of credit to be cancelled after the third anniversary of the closing date. Any such cancellation and withdrawal may significantly affect the ability of noteholders to receive payments under their notes during a currency exchange control event occurring after any such cancellation, withdrawal and refund.
 
RISKS RELATING TO THE INSURANCE POLICY
 
Limited financial information concerning the insurer
 
The rating of the notes is in part based on the availability of the insurance policy to cover certain risks related to inconvertibility or non-transferability of amounts which may be paid by the issuer under the indenture and the notes in the event that the Brazilian government imposes limitations on the conversion of reais to U.S. dollars. No financial information concerning the insurer is included in this annual report and statutory financial statements are available from the Delaware insurance authorities. The insurer’s financial obligations are subject to pooling arrangements with its parent and certain of its affiliates, which arrangements depend on the financial condition of these entities. No financial information concerning these entities is included herein. Any decline in the financial condition of the insurer or any of these companies may impair the ability of the insurer to pay claims under the insurance policy and could result in a downgrade of the rating of the notes.
 
Limitation on amount of coverage under the insurance policy
 
The insurance policy has a policy payment limit in U.S. dollars which corresponds to the amount of scheduled interest due on the notes for eighteen months. Combined with the amounts on deposit in a reserve account or available under the letter of credit, the amounts available to the trustee from the insurance policy should be sufficient to cover the payment of interest due on the notes for up to four interest payment periods. If for any reason any currency exchange control event were to continue for a period longer than twenty-four months (four consecutive interest payment periods) during which time AmBev would otherwise be required to make payments to the trustee on behalf of the noteholders under the notes, a default may occur on the notes. In such cases, noteholders may, in certain circumstances be required to accept reais in satisfaction of AmBev’s obligation to make payments to the trustee under the notes regardless of whether such reais are then convertible into U.S. dollars or any other currency.
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See “—Risks Relating to the Notes—Judgments of Brazilian courts enforcing our obligations under the notes or the indenture would be payable only in reais”.
 
Conditional nature of the insurer’s obligation to pay under the insurance policy
 
The insurer’s obligation to make payments under the insurance policy is subject to certain conditions, limitations and exclusions including, but not limited to:
 
·  
the requirement that AmBev generally either attempts and fails to convert reais to U.S. dollars or attempts and fails to transfer U.S. dollars from Brazil to the trustee in New York;
 
·  
certain events causing the failure of AmBev to pay under the indenture, continuing for the entire 180 calendar-day waiting period under the insurance policy;
 
·  
the filing by the trustee, as the insured party under the insurance policy, of a claim with the insurer; and
 
·  
the provision of certain information by the trustee and AmBev to the insurer within the time periods proscribed by the insurance policy in connection with the filing of the claim with the insurer.
 
The failure to satisfy any such condition, if not waived by the insurer, may result in the insurer not being obligated to make any payment on the insurance policy.
 
In addition, the insurer may in certain circumstances cancel the insurance policy, exclude the payment of a claim thereunder and adjust the amount of a claim under the insurance policy.
 
Limitation on timing of payments under the insurance policy
 
The insurance policy requires that the insurer make payments in respect of a claim thereunder 180 days after the original payment schedule for principal of, and interest on, the notes. Accordingly, in the event of an acceleration of the notes prior to the maturity thereof during certain events, the insurer will not be obligated to make such payments in the event of any such acceleration.
 
 
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Information on the Company
 
History and Development of the Company
 
Overview
 
Companhia de Bebidas das Américas—AmBev is the successor of Companhia Cervejaria Brahma (“Brahma”) and Companhia Antarctica Paulista Indústria Brasileira de Bebidas e Conexos (“Antarctica”), two of the oldest brewers in Brazil. Antarctica ws founded in 1885. Brahma was founded in 1888 as Villiger & Cia. The Brahma brand was registered on September 6, 1888, and in 1904 Villiger & Cia. changed its name to Companhia Cervejaria Brahma.
 
AmBev was incorporated as Aditus Participações S.A. (“Aditus”) on September 14, 1998. AmBev, a Brazilian sociedade anônima, is a publicly held corporation incorporated under the laws of the Federative Republic of Brazil. On July 1, 1999, the controlling shareholders of Brahma and Antarctica, contributed all of their common and preferred shares in Brahma and Antarctica in exchange for shares of the same type and class of AmBev (the “controlling shareholders’ contribution”).
 
On March 31, 2001, Brahma was merged into Antarctica, and Antarctica changed its name to CBB. These transactions had no effect on AmBev’s consolidated financial statements because each of the entities was wholly owned by AmBev.
 
AmBev's principal executive offices are located at Rua Dr. Renato Paes de Barros, 1017, 4th floor, CEP 04530-001, São Paulo, SP, Brazil, tel.: (5511) 2122-1415, e-mail: ir@ambev.com.br.
 
On January 31, 2003, AmBev completed a business combination with Quilmes Industrial (Quinsa), Société Anonyme (“Quinsa”), through which AmBev acquired a 40.5% initial economic interest in Quinsa and established a leading presence in the beer markets of Argentina, Bolivia, Paraguay and Uruguay.
 
During 2003 and the first quarter of 2004, AmBev expanded its presence in the north of Latin America through a series of acquisitions by which it established a foothold in several beverage markets, such as Central America, Peru, Ecuador and the Dominican Republic.
 
On August 27, 2004, AmBev and Interbrew S.A./N.V. (now known as InBev S.A./N.V. (“InBev”)), a Belgian brewer, completed a business combination that involved the merger of an indirect holding company of Labatt, one of the leading brewers in Canada, into AmBev.  At the same time, controlling shareholders of AmBev completed the contribution of all shares of an indirect holding company of AmBev to InBev in exchange for newly issued shares of InBev.
 
On May 31, 2005, CBB merged into AmBev, a transaction which simplified AmBev’s corporate structure.
 
The Brahma-Antarctica Combination—Creation of AmBev and Brazilian Antitrust Approval
 
AmBev was formed through the combination of Brazil’s two largest beverage companies, Brahma and Antarctica (the “combination”). The combination involved the creation of AmBev, as a holding company for Brahma and Antarctica. The combination was carried out over the course of 1999 and 2000, beginning with the contribution of shares of the controlling shareholders of Brahma and Antarctica in exchange for shares of AmBev on July 1, 1999. This was followed by the completion of the transactions by which Antarctica and Brahma became wholly-owned subsidiaries of AmBev on September 15, 1999 and September 14, 2000, respectively, and the public shareholders of Brahma and Antarctica became shareholders of AmBev. Pursuant to the controlling shareholders’ contribution on July 1, 1999, Brahma’s controlling shareholders, Empresa de Administração e Participações S.A. - ECAP (“ECAP”) and Braco S.A., and Antarctica’s controlling shareholder, the  FAHZ, each contributed all its common and preferred shares in Brahma and Antarctica, respectively, in exchange for AmBev shares of the same type and class.
 
 
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In connection witih the combination, on July 1, 1999, the FAHZ, Braco S.A., and ECAP, the controlling shareholders of AmBev, as well as AmBev and Marcel Telles, Jorge Paulo Lemann and Carlos Alberto Sicupira, entered into a shareholders’ agreement that contains provisions relating to the voting of shares of AmBev and the voting by AmBev of the shares of its subsidiaries. Messrs. Telles, Lemann and Sicupira are indirectly part of the control block of InBev Brasil (formerly known as Braco Investimentos S.A.) InBev Brasil holds all of the AmBev shares previously held by Braco S.A. and has succeeded to Braco S.A.’s rights and obligations under the AmBev shareholders’ agreement and had ECAP merged into it on June 24, 2005. For a detailed description of the AmBev shareholders’ agreement, see “Major Shareholders and Related Party Transactions—Major Shareholders—AmBev Shareholders’ Agreement”.
 
Brazilian antitrust authorities have the power to investigate any transaction that may limit or impair competition, or result in a dominant market position, including transactions that result in the concentration of a market share equal to or greater than 20% of any relevant market or which involves, among other factors, any company with annual gross sales of R$400 million or more. The transfer of control of Brahma and Antarctica to AmBev through the controlling shareholders’ contribution resulted in a market share for AmBev in excess of 70% of the Brazilian beer market and 20% of the Brazilian soft drinks market. Brazilian antitrust authorities therefore reviewed the transaction to determine whether it would negatively impact competitive conditions in the relevant markets, or whether it would negatively affect consumers.
 
The CADE, an independent agency of the Brazilian Ministry of Justice, is the principal Brazilian antitrust authority. On April 7, 2000, CADE approved the controlling shareholders’ contribution subject to restrictions designed to prevent AmBev from exercising excessive control over the Brazilian beer market. CADE imposed no restrictions in connection with soft drinks or other beverages produced by AmBev. On April 19, 2000, AmBev entered into a performance agreement with CADE pursuant to which AmBev agreed to comply with the restrictions imposed by CADE. The principal terms of the performance agreement included:
 
·  
Distribution network: For a period of four years, we had to share our distribution network with at least one regional Brazilian beer company, which cannot have a market share in excess of 5% of its respective regional market, in each of the five regions of Brazil as defined by CADE. On September 10, 2001, after a public bidding process, AmBev signed an agreement for the sharing of AmBev’s distribution network with Eduardo Bier Comercial de Produtos Alimenticios (“Dado Bier”);
 
·  
Plants: For a period of four years, had AmBev decided to close or dispose of any of its beer plants, it had to first offer such plant for sale in a public auction;
 
·  
Dismissals: For a period of five years, if AmBev or any of its subsidiaries had dismissed any employee as a result of the restructuring process related to the combination and other than for cause, AmBev had to attempt to place the employee in a new job, and provide the employee with retraining, as appropriate;
 
·  
Exclusivity: We and our distributors could not demand that points of sale operate on an exclusive basis, except in certain circumstances, including where our investments and improvements were equivalent to a majority of the assets of the point of sale; and
 
·  
Bavaria: A requirement that we sell Antarctica’s Bavaria brand and related assets.
 
On November 6, 2000, we entered into an agreement with Molson Inc. (which has since merged with Adolph Coors Company to form Molson Coors Brewing Company, “Molson”) for the sale of Bavaria pursuant to the terms of our performance agreement with CADE. Our agreement with Molson provided for an initial purchase price of up to R$416.1 million, of which R$191.4 million was received at that time. Molson agreed to pay an additional R$44.8 million for each 0.5% increase in market share achieved by the Bavaria brand on a yearly basis during a five year period, up to a maximum additional payment of R$224.7 million. A minimum annual market share of 6.5%, in addition to intermediary targets, should have been attained by 2005 to assure receipt of the full contingent price of R$224.7 million. Because the targets have not been met, we have not received any portion of this additional consideration. CADE approved this agreement on December 13, 2000, and the sale was completed on December 20, 2000. The agreement also provided for the sharing of our distribution network for a period of six years, renewable for an additional two-year period at the option of the purchaser. During the first four years,
 
 
21

 
 
Molson, in accordance with the agreement, would not have to pay us any commission for the use of the distribution network. On April 30, 2002, Molson decided to terminate the distribution agreement in order to enter into a distribution agreement with The Coca-Cola Company.
 
Non-compliance with any obligation under the performance agreement may trigger a minimum daily fine of R$5,320 per occurrence. This daily fine could be increased up to a maximum of R$106,410 per occurrence. In the event of non-compliance, CADE may also appoint a judicial officer to enforce compliance. CADE has the authority to revoke its approval of the controlling shareholders’ contribution and to file an administrative proceeding against us if we do not comply with our obligations. CADE also has the general authority to order other remedial measures as provided by law and as established under the performance agreement. Pursuant to the terms of the performance agreement, AmBev has to file with CADE half yearly reports attesting compliance with its terms and conditions. To date, AmBev has filed nine reports with CADE and is due to file the tenth and last report by August 31, 2005. CADE has analyzed all reports up to the eighth report and, except for the obligations in connection with exclusivity agreements and the closure of plants (in connection with which further information has been required) all other obligations under the agreement have been considered fulfilled up to the date of such reports.
 
Acquisition of Interest in Quinsa
 
On January 31, 2003, AmBev consummated the acquisition of an interest in Quinsa, an indirect holding company of Cerveceria y Malteria Quilmes, the largest Argentine brewer, and in Quilmes International (Bermuda) Ltd. (“QIB”), Quinsa’s controlled subsidiary which is the holding company for all Quinsa’s operating subsidiaries. Quinsa owned 85% of the economic interest in QIB as of January 31, 2003. This transaction involved an initial acquisition of 37.5% of the total capital Quinsa and 8.6% of the shares of QIB, resulting in a total ownership of 40.5% of Quinsa’s economic interest. The transaction included:
 
·  
the purchase of 230.9 million Class A Quinsa shares from Beverage Associates Corp. (“BAC”), for R$1,222.6  million (U.S.$346.4 million);
 
·  
the contribution of AmBev’s brewery assets located in Argentina, Uruguay and Paraguay, with a book value (determined under Brazil GAAP) of R$300.7 million, in exchange for 26.4 million new Class B shares issued by Quinsa; and
 
·  
the purchase of 8.0 million QIB shares from Heineken International Beheer B.V.C. (Heineken), a subsidiary of Heineken N.V., for R$206.5 million (U.S.$58.5 million).
 
During 2003, we acquired an additional 12.0 million Class B shares of Quinsa in the open market for a total consideration of R$243.7 million (U.S.$82.7 million), increasing our total economic interest in Quinsa to 49.7% at December 31, 2003. During 2004, Quinsa conducted certain share repurchases pursuant to its share buy-back program, increasing our total economic interest in Quinsa to 54.8% at December 31, 2004. As of May 2005, our total economic interest in Quinsa increased to 55.2%.
 
AmBev and BAC are parties to a shareholder’s agreement whereby each shareholder exercises 50% control over the operations of Quinsa. Accordingly, under Brazilian GAAP, Quinsa is proportionaly consolidated and under U.S. GAAP, Quinsa is accounted for under the equity method.
 
This acquisition granted AmBev access to leading positions in the Argentine, Bolivian, Uruguayan and Paraguayan markets, as well as to Quinsa’s operations in Chile. In addition, following the acquisition, AmBev has been able to distribute the Quilmes brands throughout Brazil. Pursuant to the agreement with BAC, AmBev has a call optin to acquire 373.5 million Quinsa Class A Shares held by BAC in exchange for shares of AmBev, which may be exercised by AmBev beginning in April 2009 and in April of each year thereafter.  Conversely, BAC has a put optin to sell to AmBev the 373.5 million Quinsa Class A Shares held by BAC in exchange for shares of AmBev, which may be exercised by BAC beginning in April 2003 and in April of each year thereafter.  The put option held by BAC is immediately exercisable upon a change of control of AmBev occurring prior to January 31, 2006, and will be deemed exercised in the event of a change of control of AmBev occurring after that date. We refer to  these agreements in this annual report as the Quinsa Put and Call Options.  BAC did not seek to exercise the put option in connection with the consummation of the InBev-AmBev Transactions.  The price of the shares will be calculated based on the EBITDA of both AmBev and Quinsa at the time of exchange.
 
The acquisition of AmBev's interest in Quinsa was approved with certain restrictions by the CNDC, the Argentine Antitrust Authority. The main restrictions imposed were:
 
 
22

 
 
·  
Quinsa and AmBev are required to sell the brands Bieckert, Palermo, Imperial and Norte, as well the brewery located in Lujan, where the Brahma brand was produced, to an independent brewery, which must be financially sound and which does not produce beer in the Argentine Market (the “Purchaser”).
 
·  
Quinsa and AmBev are required to submit documentation to the CNDC, evidencing their commitment to allow the Purchaser, for a period of seven years starting on the date of the sale of the assets to the Purchaser, to have access to Quinsa’s distribution network in Argentina.
 
·  
Quinsa and AmBev must commit to produce the Bieckert, Palermo and Imperial brands in its own plants on behalf of the Purchaser, for a two-year period, as from the date on which such assets are sold.
 
Companies that produced beer in Argentina may not purchase the assets we are required to sell pursuant to the CNDC's decision; however, in April, 2003, a subsidiary of Compañia Cervecerías Unidas S.A. (“CCU”) filed a lawsuit to be able to participate in any such sale. As a consequence, our compliance with the restrictions has been suspended.
 
Expansion into the North of Latin America
 
During 2003 and the first quarter of 2004, we extended our presence in Latin America through a series of transactions in the Northern region of the continent.
 
On October 24, 2002, AmBev and The Central America Bottling Corporation (“CabCorp”), PepsiCo’s anchor bottler in Central America, agreed to establish a 50-50 joint venture company to explore the beer markets in Central America and the Caribbean. The joint venture, Cerveceria Rio, built a brewing facility in 2003 in the region of Tecolután, Guatemala. Cerveceria Rio started to produce beer in September 2003, when the Brahva brand, an extension of AmBev’s Brahma brand, was launched in Guatemala. In 2004, the sales of Brahva were extended to Nicaragua, and in the beginning of 2005, to El Salvador. Brahva is sold in these three countries through Cabcorp’s distribution network.
 
On October 14, 2003, we agreed to purchase, through our Peruvian subsidiary AmBev Peru, certain production and distribution assets from Embotelladora Rivera, including two soft drinks bottling plants, for a consideration of R$ 86.7 million. Among the assets acquired were the franchise for Pepsi products in Lima and northern Peru. In connection with our expansion in Peru, in May 2005 we finalized a brewing and soft drinks bottling facility in the region of Lima, with an estimated investment of approximately R$92.1 million.
 
On December 2, 2003, we acquired 80% of the voting rights and economic interest of Cerveceria Suramericana in Ecuador, the owner of a brewing facility in the city of Guayaquil, with an annual production capacity of 900,000 hectoliters. This company ws valued at an amount equivalent to its existing debt (approximately U.S.$45 million), and was renamed AmBev Ecuador after we acquired it. In October 2004, we launched the Brahma brand in the local market.
 
On February 12, 2004, we acquired a 51.0% voting and economic interest in Embotelladora Dominicana, C. per A. (“Embodom”), PepsiCos bottler for the Dominican Republic bottler, for U.S.$60.0 million. AmBev’s stake will be increased to 66.0% by the end of 2005 through an asset contribution to Embodom consisting of U.S.$ 10 million and a brewing facility in the region of Santo Domingo, which is currently under construction.
 
InBev-AmBev Transactions
 
Summary
 
On March 3, 2004, various entities controlled by AmBev’s former controlling shareholders, Messrs. Lemann, Telles and Sicupira, entered into an agreement (the “Contribution and Subscription Agreement”) with InBev and InBev’s controlling shareholders to exchange their controlling interest in AmBev (consisting of approximately 8.25 billion AmBev common shares) for 141,712,000 newly-issued ordinary shares of InBev.
 
Also on March 3, 2004, AmBev entered into an agreement (the “Incorporação Agreement”) through which an indirect holding company of Labatt, one of the leading brewers in the Canadian market, would be merged into
 
 
23

 
 
AmBev. AmBev issued to InBev, the former owner of Labatt, approximately 7.9 billion AmBev common shares and 11.4 billion AmBev preferred shares.
 
On August 27, 2004, with the completion of the transactions contemplated by these agreements, which we refer to collectively as the “InBev-AmBev Transactions”:
 
·  
Labatt became a wholly owned subsidiary of AmBev;
 
·  
Interbrew S.A./N.V. was renamed InBev S.A/N.V.;
 
·  
InBev acquired a total of 16,120,095,140 AmBev common shares and 11,398,181,319 AmBev preferred shares, representing a 68.6% voting interest and a 49.8% economic interest in AmBev as of August 31, 2004. Pursuant to Brazilian law, InBev was required to conduct, following the consummation of the agreements above mentioned, a mandatory tender offer (“MTO”) for all remaining outstanding common shares of AmBev. The MTO was completed on March 29, 2005, and InBev acquired an additional 2,960,070,177 AmBev common shares, increasing its stake in AmBev to a 81.0% voting interest and 55.9% economic interest as of April 30, 2005; and
 
·  
Messrs. Lemann, Telles and Sicupira acquired 141,712,000 InBev shares, representing approximately a 24.7% voting and economic interest in InBev; Messrs. Lemann, Telles and Sicupira, together with InBev’s existing controlling shareholder group, jointly and equally, indirectly through a holding company named Stichting Interbrew, exercise control over approximately 321,712,000 InBev shares, representing approximately a 56% voting and economic interest in InBev.
 
 
AmBev believes these transactions will allow AmBev to develop a presence in the Canadian beer market, provide an opportunity for InBev to sell AmBev’s brands under license in the countries where InBev operates, and offer the potential for AmBev to benefit from InBev’s brand portfolio in countries where AmBev operates.
 
Acquisition of Labatt - Incorporação Agreement
 
On March 3, 2004, AmBev entered into the Incorporação Agreement with InBev, Labatt and Mergeco. Pursuant to the Incorporação Agreement, Mergeco was merged into AmBev by means of an Incorporação under Brazilian law, and InBev indirectly received approximately 7.9 billion newly issued AmBev common shares and approximately 11.4 billion newly issued AmBev preferred shares. Mergeco held 99.9% of the capital stock of Labatt ApS. As a result, with the completion of the Incorporação, AmBev held 99.9% of the capital stock of Labatt ApS, and indirectly, of Labatt, as well as C$1.3 billion of third-party net debt then held by Labatt and its subsidiaries. AmBev did not, however, receive assets held by Labatt USA L.L.C., as those were transferred to InBev prior to the closing of the Incorporação Agreement.
 
AmBev accounted for this transaction as an acquisition of Labatt for both Brazilian GAAP and U.S. GAAP reporting. The U.S. GAAP reporting was based on the substantive participating rights that FAHZ enjoys under the AmBev Shareholders’ Agreement.
 
Contribution and Subscription Agreement
 
On March 3, 2004, S-Braco Participações S.A., Rougeval Limited, Tinsel Investments Inc., ECAP, Braco S.A., Braco Management Inc., Tinsel Participações Ltda., Tinsel Investments S.A. (“Tinsel Lux”), BRC S.A. (“BRC”) and Bracopar S.A. (collectively, the “SB Group Companies”) entered into the Contribution and Subscription Agreement with the Stichting Interbrew (the “Stichting”), Eugénie Patri Sébastien (“EPS”), and InBev. Messrs. Lemann, Telles and Sicupira controlled, directly or indirectly, all of the SB Group Companies. The Stichting is a foundation organized under Dutch law which held, as of March 3, 2004, on behalf of EPS and affiliates of EPS approximately 275.1 million ordinary shares of InBev, representing approximately 63.7% of the outstanding ordinary shares of InBev.
 
On August 27, 2004, upon completion of the transactions contemplated by the Contribution and Subscription Agreement, BRC contributed to InBev 100% of the capital stock of Tinsel Lux that indirectly owned (i) a total of approximately 4.2 billion AmBev common shares and (ii) approximately 98.64% of the capital stock of ECAP, which directly held approximately 4.0 billion AmBev common shares. In exchange for the contribution to InBev of 100% of the capital stock of Tinsel Lux, InBev issued to BRC approximately 141.7 million ordinary shares of InBev.
 
 
24

 
 
Upon completion of the transactions contemplated by the Contribution and Subscription Agreement, Messrs. Lemann, Sicupira and Telles beneficially owned, through their interests in BRC, the InBev shares acquired by BRC, and InBev beneficially owned the AmBev common shares that were beneficially owned by Messrs. Lemann, Sicupira and Telles by virtue of their interests in the SB Group Companies.
 
Mandatory Tender Offer
 
As required by Brazilian law, InBev launched on February 14, 2005 a MTO for all common shares of AmBev not owned by it, offering to AmBev common shareholders who tendered their common shares (a) a cash payment option, consisting of an amount in reais equal to 353.28 for each 1,000 AmBev common shares tendered and (b) a stock payment option, consisting of 13.827166 InBev ordinary shares for each 1,000 AmBev common shares tendered. On March 29, 2005, the auction consummating the MTO took place on the premises of the São Paulo Stock Exchange (“Bovespa”) and on March 31, 2005, InBev announced that 1,612,915,545 AmBev common shares were tendered in exchange for the cash payment option in the auction and 1,347,155,632 AmBev common shares were tendered in exchange for the stock payment option in the auction. As a result of the settlement of the MTO on May 3, 2005, InBev acquired (directly and indirectly) 2,960,070,177 AmBev common shares.
 
InBev Shareholders’ Agreement
 
According to publicly-available information, we understand that, in connection with the Contribution and Subscription Agreement, on March 2, 2004, BRC, EPS, an affiliate of EPS, Rayvax Société d’Investissements S.A.  (“Rayvax”) and the Stichting entered into a shareholders agreement (the “InBev Shareholders’ Agreement”) that became effective on August 27, 2004. The InBev Shareholders’ Agreement provides for BRC and EPS to hold their interests in InBev through the Stichting and addresses, among other things, certain matters relating to the governance and management of the Stichting and InBev as well as the transfers of interests in InBev. On August 27, 2004, BRC transferred all 141,712,000 of its InBev shares to the Stichting in exchange for 141,712,000 Stichting certificates, and EPS held 180,000,000 Stichting certificates (representing 180,000,000 million InBev shares). As of December 31, 2004, the 321,712,000 InBev shares held by the Stichting represented 55.8% of all issued and outstanding InBev shares at that time. Pursuant to the terms of the InBev Shareholders’ Agreement, BRC and EPS will jointly and equally exercise control over the Stichting and the InBev shares held by the Stichting.
 
The InBev Shareholders’ Agreement provides for restrictions on the ability of BRC and EPS to transfer their Stichting certificates (and consequently their InBev shares held through the Stichting). EPS has agreed that it will at all times hold, directly or indirectly, no less than 180,000,000 Stichting certificates (representing 180,000,000 InBev shares), and BRC has agreed that it will at all times hold, directly or indirectly, no less than 141,712,000 Stichting certificates (representing 141,712,000 InBev shares). In addition, the InBev Shareholders’ Agreement requires certain affiliates of EPS whose InBev shares are not held through the Stichting to vote their InBev shares in the same manner as the InBev shares held by the Stichting and will restrict such affiliates’ ability to transfer their InBev shares in a manner that would disrupt the orderly trading of the InBev shares. In addition, under the InBev Shareholders’ Agreement, EPS and BRC agreed not to acquire any shares of capital stock of AmBev, subject to limited exceptions.  The InBev Shareholders’ Agreement will remain in effect for an initial term of 20 years from August 27, 2004. Thereafter, the InBev Shareholders’ Agreement will be automatically renewed for successive renewal terms of 10 years each unless, not later than two years prior to the expiration of the initial or any renewal term, either BRC or EPS notifies the other of its intention to terminate the agreement.
 
Investment Grade Status
 
In December 2004, Standard & Poor’s raised AmBev’s risk rating denominated in foreign currency from BB- to BBB-, three levels above the Brazilian government’s sovereign risk, making AmBev the first Brazilian company to obtain the investment grade status.
 
25

Merger of CBB into AmBev
 
On May 31, 2005, in order to simplify AmBev’s corporate structure, CBB merged into AmBev. AmBev held 99.99% of CBB, and issued 26,585 new AmBev common shares to CBB minority shareholders, representing an increase in AmBev’s shareholders’ equity of approximately R$4,000.
 
Share Dividend
 
On May 31, 2005, the Board of Directors of AmBev approved a share dividend to each shareholder of AmBev at a rate of one  common share for every five preferred shares and/or common shares held by such shareholder on that date. Pursuant to the terms of the share dividend, AmBev issued a total of 10,941,151,072 common shares. As a result of the share dividend, InBev Brazil received an additional 6,095,669,326 common shares, and FAHZ received an additional 848,947,447 common shares. As of May 31, 2005, InBev's voting interest in AmBev was of 73.0%, while its economic interest was 55.7%.
 
Business Overview
 
Description of the Company
 
We are the largest brewer in Latin America in terms of sales volumes and the fifth largest beer producer in the world, according to our estimates. We produce, distribute and sell beer, soft drinks and other non-alcoholic and non-carbonated products in 14 countries across the Americas. We are PepsiCo’s largest bottler outside the United States.
 
We conduct our operations through three business units:
 
·  
Brazil, which includes three divisions: (i) beer sales (“Beer Brazil”); (ii) carbonated soft drinks and non-alcoholic non-carbonated sales (“CSD & NANC”); and (iii) sales of malt and by-products to third parties (“Other Products”);
 
·  
Hispanic Latin America (“HILA”), which includes AmBev’s stake in Quinsa, and the operations of our subsidiaries in the Dominican Republic, Ecuador, Guatemala (which also serves Nicaragua and El Salvador), Peru and Venezuela. We refer to our HILA operations, excluding Quinsa and its subsidiaries, as “HILA-ex”); and
 
·  
North America, represented by Labatt’s operations, which includes domestic sales in Canada and beer exports to the United States.
 
The following map illustrates the main locations where our business units operate:
 
map
 
The following table presents a breakdown of our net revenues by business division:
 
 
Net Proceeds
Year ended December 31,
 
 
2003
 
2002
Brazil
   
8,525.9
   
71.0
%
 
7,637.7
   
88.0
%
 
6,928.9
   
94.6
%
Beer Brazil
   
6,907.4
   
57.5
%
 
6,114.6
   
70.4
%
 
5,546.4
   
75.7
%
CSD & NANC
   
1,462.8
   
12.2
%
 
1,332.1
   
15.3
%
 
1,096.2
   
15.0
%
Other Products
   
155.8
   
1.3
%
 
190.9
   
2.2
%
 
286.3
   
3.9
%
HILA
   
1,922.1
   
16.0
%
 
1,046.1
   
12.0
%
 
396.3
   
5.4
%
Quinsa(1)
   
1,153.0
   
9.6
%
 
773.7
   
8.9
%
 
   
 
HILA-ex
   
769.1
   
6.4
%
 
272.4
   
3.1
%
 
396.3
   
5.4
%
North America(2)
   
1,558.8
   
13.0
%
 
   
   
   
 
AmBev Consolidated
   
12,006.8
   
100.0
%
 
8,683.8
   
100.0
%
 
7,325.2
   
100.0
%
_______________
(1) Quinsa’s net revenues in proportion to AmBev’s economic stake in Quinsa.
(2) Consists of the results of Labatt’s operations from August 27, 2004 through December 31, 2004.
 
Source: AmBev
26

The following table presents a breakdown of AmBev’s sales volumes by business division:
 

 
Sales Volumes
Year ended December 31,
 
 
2003
 
2002
Brazil
   
76,884.9
   
70.6
%
 
74,058.4
   
78.3
%
 
77,650.4
   
95.2
%
Beer Brazil
   
57,776.8
   
53.1
%
 
55,260.2
   
58.4
%
 
58,009.6
   
71.1
%
CSD & NANC
   
19,108.2
   
17.6
%
 
18,798.3
   
19.9
%
 
19,640.8
   
24.1
%
Other Products
   
   
   
   
   
   
 
HILA
   
28,333.2
   
26.0
%
 
20,301.3
   
21.7
%
 
3,909.1
   
4.8
%
Quinsa(1)
   
22,145.9
   
20.3
%
 
18,514.6
   
19.6
%
 
   
 
HILA-ex
   
6,187.2
   
5.7
%
 
2,056.6
   
2.2
%
 
3,909.1
   
4.8
%
North America(2)
   
3,621.3
   
3.3
%
 
   
   
   
 
AmBev Consolidated
   
108,839.4
   
100.0
%
 
94,629.6
   
100.0
%
 
81,559.5
   
100.0
%
 
_______________
(1) Includes 100% of the sales volumes of Quinsa.
(2) Consists of the results of Labatt’s operations from August 27, 2004 through December 31, 2004.

 
Source: AmBev
 
Business Strategy
 
We aim to continuously improve economic value added (“EVA”). Based on this strategy our main drivers are:
 
·  
our people and culture;
 
·  
top line growth;
 
·  
distribution efficiency and execution;
 
·  
permanent cost and expense reduction; and
 
·  
financial discipline.
 

 
Our People and Culture
 
We are aware of the value and importance of  highly qualified, motivated and committed employees. We carefully manage our hiring and training process with a view to maintaining outstanding professionals among our ranks.  In addition, we believe that we have created through our compensation program, which is based on both variable payment and stock ownership, financial incentives for high performance and results. See “Directors, Senior Management and Employees Compensation – Profit Sharing Plan”).
 
Another core element of our culture is our distinguished managerial capabilities, which is summarized by: (i) hardworking ethos; (ii) results focused evaluations; (iii) the encouragement of our executives  to act as owners, not only managers; (iv) leadership through personal example; and (v) appreciation for field experience.
 
Top Line Growth
 
We are constantly seeking sustainable growth in our net revenues, primarily through four different initiatives:
 
·  
Portfolio management: we constantly pursue increased sales of premium, higher-priced and more profitable products in our sales mix;
 
27

 
·  
Maximize share of consumer expenditure: we seek to maximize our share of the consumer’s expenditure in our products;
 
·  
Market share: we are committed to maintaining and strenghtening our leading position in the markets where we operate, as well as to evaluating opportunities to establish a presence in new markets across the Americas where we currently do not operate; and
 
·  
Increase per capita consumption: based on proprietary research focused on consumer behavior and occasions of consumption, we aim to increase per capita consumption in the markets where we operate.
 
Distribution Efficiency and Execution
 
Delivering national beer brands to hundreds of thousands of points of sale is the most complex feature of our business. In recent years, we have been focusing on direct distribution in major cities while still strengthening our third-party distribution system.  In Brazil, for instance, instead of operating three inherited, parallel, single-brand systems (each of them dedicated to one of our major brands, Skol, Brahma and Antarctica), we are shifting towards a multi-brand network of distributors committed to handling all of our brands.
 
In addition, we are constantly seeking to improve our point of sale execution through new and creative measures. One of our key marketing initiatives was the introduction into the Brazilian market of our custom-made beer refrigerators designed and built to chill beer at the optimal temperature for on-premise consumption. These refrigerators also work as effective marketing tools, as they are decorated with images related to our core brands.

 
Permanent Cost and Expense Reduction
 
Cost and expense control is one of our employee’s top priorities. Each of our departments must comply with its respective annual budget for fixed costs; the employees of those departments which exceed the budget are not entitled to bonuses.
 
As a measure to avoid unnecessary expenses, we have designed a management control system inspired in zero-base budgeting procedures. That system demands that every manager builds the annual budget for his or her respective department from scratch.

 
Financial Discipline
 
We have a policy of not retaining unnecessary cash. Through a combination of dividends and share buy-backs, we have returned to our shareholders the cash flow generated by our operations, after allocating funds for our operational needs and investment plans.

 
Seasonality
 
Sales of beverages in our markets are seasonal. Generally, sales are stronger during the start of the summer and major holidays in the regions. Therefore, in the Southern Hemisphere (Brazil and HILA) volumes are usually stronger in the fourth quarter due to early summer and year-end festivities. In North America volumes are stronger in the second and third quarters due to the summer season. This is demonstrated by the table below, which sets forth our volumes by quarter and business division:
 
28

 
 

 
2004 Quarterly Volumes
 
(As a percentage of annual volumes)
 
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
2004
Brazil
23.2%
21.1%
24.0%
31.7%
100.0%
Beer Brazil
22.8%
21.0%
24.3%
31.9%
100.0%
CSD & NANC
24.3%
21.4%
23.1%
31.2%
100.0%
HILA
26.5%
19.6%
22.4%
31.5%
100.0%
Quinsa
27.9%
18.5%
21.5%
32.1%
100.0%
HILA-ex
21.4%
23.6%
25.5%
29.5%
100.0%
North America(1)
19.6%
28.6%
27.2%
24.6%
100.0%
AmBev Consolidated
23.6%
21.5%
23.9%
31.0%
100.0%
(1) Results for North America reflect the total volumes for Labatt in 2004.
 
Description of The Markets Where We Operate
 
Brazil
 
The Brazilian beer market
 
In 2004, Brazil was the world’s fourth largest beer market in terms of volume. According to Canadean, total sales volumes in 2004 reached 84.5 million hectoliters. Beer is predominantly sold in bars for on-premise consumption, in standardized, returnable 600 milliliters glass bottles. The second most important packaging presentation is the 350 milliliters one-way aluminum can, which is predominantly sold in supermarkets for off-premise consumption.
 
As of May 2005, according to ACNielsen, we had a 68.3% market share in terms of beer sales volumes, mainly through our three major brands, Skol, Brahma and Antarctica. Our closest competitors in Brazil are: Grupo Schincariol with a 12.7% market share; Molson with a 8.7% market share; and Cervejaria Petrópolis S/A with a 5.2% market share.
 
Distribution represents one of the most complex features in this market, as the retail channel is fragmented into more than one million points of sale. Our distribution is structured under two separate branches. One of them is our network of exclusive third-party distributors, involving more than 300 operators. The other branch is our proprietary direct distribution system, involving more than 30 distribution centers spanned over most regions of Brazil. We have been focusing on direct distribution in large urban regions, while still strengthening our third-party distribution system. See Business Strategy”.
 
The Brazilian soft drinks market
 
The soft drinks market in Brazil is comprised of many different segments, including carbonated soft drinks (“CSD”), bottled water, isotonics, iced teas, juices and juice drinks. The CSD segment is the most relevant one for us, representing more than 90% of the profits or our CSD & NANC business unit. We also sell isotonics, iced tea and bottled water.
 
In 2004, Brazil was the world’s third largest CSD market, after the United States and Mexico. The main flavors are (i) black cola, (ii) guaraná, (iii) orange, and (iv) lime. Most of the carbonated soft drinks in Brazil are sold in supermarkets in 2-liters one-way PET bottles, for off-premise consumption. Specifically for our portfolio, the 350 milliliters one-way aluminum can is also an important packaging presentation, and is mainly sold in supermarkets.
 
Our main competitor in this market is The Coca Cola Company, which operates in Brazil though approximately 20 bottlers. As of May 2005, according to ACNielsen, The Coca Cola Company family of brands had a 53.3% market share in the Brazilian soft drinks market, while we had a market share of 16.4%. Apart from The Coca Cola Company, we face competition from small regional producers, that produce what is usually referred to as “B Brands”. The B Brands compete mainly in price, usually being sold at a significantly lower price than our products.
 
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Our main CSD brands are Guaraná Antarctica, the leader in the guaraná flavor segment, and Pepsi Cola, which is sold under license from PepsiCo. We also have in our portfolio the brands Gatorade, in the isotonics market, and Lipton Ice Tea, in the iced tea market.
 
Our CSD & NANC products are sold through the same distribution system used for beer.
 
HILA
 
Quinsa
 
A description of the beer and soft drink markets in the regions where Quinsa operates can be found in Quinsa’s annual report on Form 20-F, which will be filed with the Securities and Exchange Commission. Please refer to that description for an understanding of the Quinsa market.
 
 
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HILA-ex
 
Central America (including Guatemala, El Salvador and Nicaragua)
 
According to Canadean, the beer markets in Central America where we operate had combined annual sales volumes of 3.3 million hectoliters in 2004. In these markets, beer is predominantly sold in returnable bottles in small retail stores.
 
In El Salvador, the main packaging presentation is the returnable, 12oz. glass bottle. Our main competitor in El Salvador is the market leader, a local subsidiary of SABMiller plc.
 
In Guatemala, the main packaging presentation is the returnable, 12oz. glass bottle. Our main competitor in Guatemala is Cerveceria Centro Americana, the market leader. Cerveceria Centro Americana is a private company held by local investors.
 
In Nicaragua, the main packaging presentation is the returnable, 1.0 liter glass bottle. Our main competitor  in Nicaragua is the market leader, which is a joint venture among Guatemala’s Cerveceria Centro Americana and a Costa Rican investor’s group named Florida Ice & Farm.
 
In all three of these markets we sell our Brahva brand, which is distributed through CabCorp’s distribution system, jointly with CabCorp’s soft drinks portfolio.
 
The Dominican Republic
 
The Dominican CSD market
 
According to our estimates the Dominican CSD market annual sales volumes were 2.4 million hectoliters in 2004. The main packaging presentation is the returnable, half-liter glass bottle, which is predominantly sold in small retail stores. We are the leading player in that market, and compete with The Coca Cola Company, represented by its local bottler.
 
We entered the Dominican CSD market in February 2004 through the acquisition of a controlling stake in Embodom, PepsiCo’s Dominican Republic bottler. Our main brands in that country are Red Rock, Pepsi Cola and Seven UP (the latter two under license from PepsiCo).
 
Our Dominican Republic distribution system is comprised of direct distribution operations and third-party distributors.
 
The Dominican beer market
 
According to Canadean, the Dominican beer market annual sales volumes are estimated at 2.8 million hectoliters in 2004. The main packaging presentation in that country is the returnable, 650 milliliters glass bottle, which is predominantly sold in small retail stores. Currently, only one brewer, Cerveceria Presidente, operates in the
 
31

 
Dominican market. Cerveceria Presidente is a joint venture among local investors and a subsidiary of the Altria Group, Inc.
 
In connection with our expansion in the Dominican CSD market, we are building a brewing and soft drinks bottling facility in the region of Santo Domingo, which will allow us to start selling beer in that country. The plant is expected to start operations by the fourth quarter of 2005.
 
We expect to sell beer in the Dominican Republic through the same distribution system used in the CSD business.
 
Ecuador
 
According to Canadean the Ecuadorian beer market annual sales volume is estimated at 3.2 million hectoliters in 2004. The main packaging presentation in that country is the returnable, 578 milliliters glass bottle,
 
 
 
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predominantly sold in small retail stores. The leading player in that market is the Colombian brewer, Grupo Empresarial Bavaria.
 
We entered the Ecuadorian beer market through the acquisition of Cerveceria Suramericana in December 2003, which had by that time less than 5% market share through its own Biela brand. In October 2004, we discontinued Biela and launched the Brahma brand in Ecuador.
 
Our distribution system in Ecuador is comprised of direct distribution operations and third-party distributors.
 
In 2004, we entered into a legal dispute with Grupo Empresarial Bavaria, claiming the right to use common-shaped returnable beer bottles (578 milliliters) that are widely available in the local market.  The purpose of the dispute is to allow full interchangeability between our bottles and those carried by other market players.  Ecudorian courts have not yet reached a final decision on this matter, and we cannot anticipate when the dispute will be resolved.  We currently use a proprietry returnable beer bottle (578 mililiters) in Ecuador.
 
Peru
 
The Peruvian CSD market
 
According to our estimates, the Peruvian CSD market annual sales volumes were 11.5 million hectoliters in 2004. The main packaging presentation in that country is the 3.0 liters one-way PET bottle, which is predominantly sold in small retail stores. The leading player in that market is The Coca Cola Company, represented by its local network of bottlers. We also face competition from small regional producers, that produce what is usually referred to as “B Brands”. The B Brands compete mainly in price, usually being sold for a significantly lower price than our products.
 
We entered the Peruvian CSD market in November 2003 through the acquisition of certain production and distribution assets from Embotelladora Rivera, including the PepsiCo franchise for the region of Lima and northern Peru. The main brands that we sell in Peru are Concordia, Pepsi Cola and Triple Kola, all of which are sold under license from PepsiCo.
 
Our distribution system in Peru is comprised of direct distribution operations and third-party distributors.
 
The Peruvian beer market
 
According to Canadean, the Peruvian beer market annual sales volumes are estimated at 6.5 million hectoliters in 2004. The main packaging presentation in that country is the returnable, 620 milliliters glass bottle, which is predominantly sold in small retail stores. The market leader is the Colombian brewer, Grupo Empresarial Bavaria.
 
In connection with our expansion in the Peruvian CSD market, we finalized in May 2005 a brewing and soft drinks bottling facility in the region of Lima, which allows us to start selling the Brahma beer brand in that country.
 
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The same distribution system used in Peru for our CSD business is also used for the beer sales.
 
In 2004, we entered into a legal dispute with Grupo Empresarial Bavaria, claiming the right to use common-shaped returnable beer bottles (620 milliliters) that are widely available in the local market.  The purpose of the dispute to allow full interchangeability between our bottles and those carried by other market players.  Peruvian courts have not yet reached a final decision on this matter, and we cannot anticipate when the dispute will be resolved.  We currently use a 1.1 liter returnable beer bottle in Peru.
 
Venezuela
 
According to Canadean, the Venezuelan beer market annual sales volumes are estimated at 14.8 million hectoliters in 2004. The main packaging presentation in that country is the returnable, 222 milliliter glass bottle, which is predominantly sold in small retail stores. We compete in Venezuela with Cerveceria Polar, the market leader, and Cerveceria Regional, the second largest player.
 
Our main brands in Venezuela are Brahma and Brahma Light, and our distribution system is comprised of direct distribution operations and third-party distributors.
 
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North America
 
Our North America business unit is represented by Labatt’s operations, which include domestic beer sales in Canada and exports of Canadian brands to the United States.
 
According to Canadean, the annual sales volumes in the beer market in Canada are estimated at 21.8 million hectoliters in 2004. The main packaging presentation in that country is the returnable, 341 milliliters glass bottle, which is predominantly sold in privately-owned and government-owned retail stores. Our main competitor in Canada is Molson, which has a market share similar to ours (approximately 42.0%). We also compete with smaller local brewers, such as Sleeman Breweries Ltd. (“Sleeman”), Moosehead Breweries Ltd. and Lakeport Brewing Corporation.
 
Our main brands in Canada are Budweiser (brewed and sold under license from Anheuser-Busch, Inc.)  ("Anheuser-Busch")), Labatt Blue, Alexander Keiths and Kokanee. Our distribution system is structured in different ways across the country:
 
Distribution in Ontario
 
In Ontario, the province with the largest beer consumption in Canada, we own in partnership with Molson and Sleeman, a distribution and retail company named Brewers Retail Inc., the retail component of which carries out business as The Beer Store (“TBS”). TBS and the Liquor Control Board of Ontario, a chain of liquor stores owned by the government of the Province of Ontario (“LCBO”), own the exclusive rights to sell beer for off-premise consumption in Ontario. TBS also has the exclusive rights to supply domestic-produced beer to the LCBO.
 
Domestic brewers are entitled to hire the distribution and retail services of TBS, which charges a one-off fee for the registration of each stock keeping unit in its portfolio, plus a fee for service for each case delivered to the LCBO or sold in its proprietary stores.
 
TBS also serves points of sale in Ontario where beer is consumed on premise; there are, however, no rights for exclusive supply. Any brewer can sell its products directly to points of sale where beer is consumed on premise.
 
AmBev, Molson and Sleeman share all the seats on the board of TBS, with AmBev and Molson jointly controlling its operations.
 
Distribution in Quebec
 
Quebec is the province in Canada with the second largest beer consumption. In this province there is no exclusive rights for the sales of beer, and both the on-premise and off-premise sales channels are mostly comprised of privately owned stores.
 
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We sell our products in Quebec through a direct sales system.
 
Distribution in the Western Provinces
 
In the Western Provinces (including Alberta, British Columbia, Manitoba, Saskatchewan, the Yukon and the Northwest Territories), we and Molson own a joint-venture company that distributes our and Molson’s products to the retail stores.
 
Distribution in the Atlantic Provinces
 
We sell our products through a network of third-party distributors in the Atlantic Provinces (including New Brunswick, Newfoundland, Nova Scotia and Prince Edward Island).
 
Exports to the United States
 
We sell some of our brands in the United States, including Labatt Blue and Kokanee, through InBev USA (previously Labatt USA, L.L.C.), a subsidiary of InBev. We have no written agreement to sell through InBev USA. See “Major Shareholders - Related Party Transactions”.
 
 
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Beer and Soft Drink Production Process
 
Beer production involves several raw material and production stages. The main ingredient in beer is malt, which is produced by germinating and roasting barley in a process called “malting”. Malt is mixed with water, hops and adjuncts (corn syrup, grits or rice, for instance) in the proportions necessary to obtain the desired taste. The resulting mixture is called “wort”. Wort is fermented with selected yeasts to produce beer, which is then filtered and bottled. In addition to these inputs, delivery of the product to consumers requires packaging such as bottles, aluminum or steel cans, labels and crown caps.
 
Soft drinks are produced by mixing water, flavored concentrate and sugar or sweetener. Water is processed to eliminate mineral salts and filtered to eliminate impurities. Purified water is combined with processed sugar or, in the case of diet soft drinks, with artificial sweeteners, and concentrate. Carbon dioxide gas is injected into the mixture to produce carbonation. Immediately following carbonation, the mixture is bottled. In addition to these inputs, delivery of the product to consumers requires packaging such as PET bottles, aluminum or steel cans, labels and plastic closures.
 
For information on our production facilities, see “— Property, Plant and Equipment”.
 
Sources and Availability of Raw Materials
 
Beer
 
The main raw materials used in our production are malting barley, malt, gritz, corn syrup, rice, hops and water.
 
Barley and malt
 
Malt is widely available and our requirements are met by domestic and international suppliers as well as our own malting facilities. In the case of our beer operations in Brazil, over half of our malt needs are supplied by our own malting facilities located in the south of Brazil, Argentina and Uruguay.
 
Our most significant malt suppliers are Canada Malting, Soufflet, Boortmalt and Malterias Unidas. Market prices for malt are volatile, and depend on the quality and the level of production of the barley crop across the world, as well as on the intensity of demand.
 
We purchase barley for our malting facilities directly from farmers resident in Brazil, Argentina and Uruguay. Barley prices depends on the quality of the barley crop and on the prices for wheat on the main boards of trade across the world.
 
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Hops
 
There are two types of hops used in our beer production: hops used to give beer its distinctive bitter flavor, which we generally import from the United States, and hops used to give beer its distinctive aroma, which we generally import from Europe.  The supply of hops is concentrated by few international companies, namely the Barth - Haas Group, Yakima Chief, Inc., Hopsteiner and HVG Hopfenverwertungsgenossenschaft. There are generally several suppliers available to meet our needs.
 
Adjuncts
 
Corn syrup, gritz and rice are purchased locally by each one of our operations and are generally widely available.
 
  Water
 
Water represents a small portion of our raw material costs. We obtain our water requirements from several sources, such as: lakes and reservoirs, deep wells located near our breweries, rivers adjoining our plants and public utilities companies. We monitor the quality, taste and composition of the water we use, and treat it to remove impurities and
 
 
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to comply with our high quality standards and applicable regulations. As a result of advances in technology, we have continuously reduced our water consumption per hectoliter produced. We do not foresee any shortage in our current water supply.
 
Soft drinks
 
The main raw materials used in our production are: concentrate (including guaraná extract), sugar, sweetener, water and carbon dioxide gas. Most of these materials are obtained from local suppliers.
 
Guaraná fruit
 
We have a 505 hectare farm that provides us with 50 to 60 tons of guaraná berries per year, or about 18% of our requirements, with the remainder purchased directly from independent farmers in the Amazon region.
 
Concentrates
 
We have a concentrate facility in the north of Brazil which produces the concentrates to meet our requirements for the production of our proprietary brands. The concentrate for Pepsi soft drink products is purchased from PepsiCo.
 
  Sugar
 
Sugar is widely available and is purchased locally by each of our operations. We enter into derivative instruments to avoid the impact of short-term volatility in sugar prices on our production costs. See “Quantitative and Qualitative Disclosure about Market Risk”.
 
Other
 
We produce all of the fruit juice, pulp and concentrate that we use in the manufacture of our fruit flavored soft drinks.
 
Packaging
 
Packaging costs are comprised of the cost of glass and PET bottles, aluminum and steel cans, plastic film (shrink and stretch), paper labels, plastic closures, metal crowns and paperboard. We enter into derivative instruments to avoid the impact of short-term volatility in aluminum prices on our production costs; for further information on this matter see “Quantitative and Qualitative Disclosures About Market Risk”. For other materials, we usually set a fixed price for the period in accordance with the prevailing macroeconomic conditions.
 
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Our main can suppliers are Rexam, Latapack Ball, Metalic and Crown-Cork. We generally purchase all of the glass bottles used in packaging of our products from St. Gobain Emballage, Owens-Illinois Glass Containers and Companhia Industrial de Vidros. We obtain the labels for our beer and soft drink primarily from local suppliers; in Brazil, the majority of our requirements are met by a printing house that belongs to the FAHZ. Plastic closures are principally purchased from Alcoa Aluminio and Crown-Cork. PET pre-forms are principally purchased from Amcor. Crown caps are sourced locally by each of our operations. In Brazil and some of our HILA-ex operations, a significant part of our crown caps requirements are met by our facility in the north of Brazil.
 
Regulation
 
All our operations are subject to local governmental regulation and supervision, including (i) labor laws; (ii) social security laws; (iii) public health, consumer protection and environmental laws; (iv) securities laws; and (v) anti-trust laws. In addition, regulations exist to (i) ensure healthy and safe conditions in facilities for the production, bottling, and distribution of beverages and (ii) place restrictions on beer consumption.
 
Environmental laws in the countries where we operate are mostly related to (i) the conformity of our operating procedures with environmental standards regarding, among other issues, the emission of gas and liquid effluents and (ii) the disposal of one-way packaging.
 
Governmental restrictions on beer consumption in the markets where we operate vary from one country to another, and in some instances, from one local region to another. The most relevant restrictions are:
 
·  
Each country has a minimum legal drinking age that is established by the government; the legal drinking age varies from 18 to 21 years.
 
·  
Some local and federal governments require that retail stores own special licenses for the sales of alcohol; this is the case in Venezuela, some regions of Argentina and Canada.
 
·  
Some local governments in Canada establish a minimun price for beer sales, which is named Social Reference Price (“SRP). There is a specific SRP for each different packaging presentation. The SRP may vary from one province to another.
 
·  
Beer sales in the off-premise channel in Canadian provinces of New Brunswick, Newfoundland, Nova Scotia, Prince Edward Island and Saskatchewan are restricted to specific government owned stores.
 
·  
Beer sales in the off-premise channel in Canada in the Province of Ontario are restricted to two chains of retail stores. One of them is the LCBO, which is government owned, and the other is TBS, jointly owned by AmBev, Molson and Sleeman. The Alcohol and Gaming Commission of Ontario regulates the alcohol industry and recently the Government of Ontario has established an independent panel to review beverage alcohol policies in Ontario, and as part of this exercise The Beer Store is undergoing heightened government scrutiny.  It is difficult to determine the approach that the Government will take.
 
Many governments also impose restrictions on beer advertisement, which may affect, among other issues, (i) the media channels used, (ii) the contents of advertising campaigns; and (iii) the time and places where beer can be advertised.
 
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Licenses
 
AmBev entered into long term agreements with PepsiCo whereby AmBev was granted the exclusive right to bottle, sell-, and distribute certain brands of PepsiCo’s portfolio of soft drinks in Brazil, including Pepsi Cola, Seven Up and Gatorade. The agreements will expire on December 31, 2017.  See Additional InformationMaterial Contracts.  AmBev also has agreements with PepsiCo to manufacture, package, sell, distribute and market some of its brands in the Dominican Republic and in some regions of Peru, including the north and the Lima regions. Through Quinsa, AmBev is also PepsiCo’s bottler for the majority of the Argentine territory and Uruguay.
 
In 2004, sales volumes of PepsiCo products represented 38.5% of total CSD & NANC sales volumes in Brazil, 64.8% of total CSD & NANC sales volumes in the Dominican Republic and all of CSD & NANC sales volumes in Peru.
 
Effective January 1, 1998, Labatt entered into long term licensing agreements with Anheuser-Busch whereby Labatt was granted the exclusive right and license to manufacture, package, sell, distribute and market some of Anheuser-Busch’s brands, including the Budweiser and Bud Light brands, in Canada, including the right to use Anheuser-Busch’s trademarks for those purposes. The agreements expire January 1, 2098 and are renewable by either party for a second term of 100 years.

In the period from September through December 2004, the Anheuser-Busch brands sold by Labatt represented 25.7% of Labatt’s total sales volumes. According to AmBev’s estimates, the Budweiser brand is currently the largest selling brand in terms of volume in Canada.
 
On March 21, 2005, AmBev and InBev entered into a 10-year cross-license agreement through which AmBev is allowed to produce, package, market and distribute beer under the brands Stella Artois and Beck’s in Latin America (except Argentina and Cuba) on an exclusive basis, and InBev is allowed to produce, package, market and distribute beer under the brand Brahma in Europe, Asia, Africa, Cuba and the United States on an exclusive basis. Since March 23, 2005, InBev has launched the Brahma brand in the United States and in a number of European countries such as United Kingdom, France, the Benelux, Ukraine and Russia. We announced the launch of the Stella Artois brand in Brazil on June 28, 2005.  In addition, Labatt and InBev have an arrangement through which Labatt can distribute Stella Artois branded beer in Canada. See “Major Shareholders and Related Party TransactionsRelated Party Transactions.”
 
Taxation
 
Beer
 
Taxation on beer in the countries where we operate is comprised of excise tax and value-added tax. The amount of sales taxes charged on our beer products in 2004 represented as a percentage of gross sales was: 55.3% in Brazil; 24.6% in Canada; 13.1% in Central America; 31.3% in Ecuador; and 31.4% in Venezuela. A description of taxation on beer in the markets where Quinsa operates can be found in Quinsa’s annual report on Form 20-F, which will be filed with the Securities and Exchange Commission. Please refer to that description for an understanding of the Quinsa market.
 
Government decisions to increase taxation on beer may affect significantly the profitability of our business.
 
  CSD & NANC
 
Taxation on CSD & NANC in the countries where we operate is comprised of excise tax and value-added tax. The amount of sales taxes charged on our CSD & NANC products in 2004 represented as a percentage of gross sales was: 46.8% in Brazil; 9.0% in the Dominican Republic; and 41.1% in Peru. A description of taxation on CSD & NANC in the markets where Quinsa operates can be found in Quinsa’s annual report on Form 20-F, which will be filed with the Securities and Exchange Commission. Please refer to that description for an understanding of the Quinsa market.
 
Government decisions to increase taxation on CSD & NANC may affect significantly the profitability of our business.
 
Organizational Structure
 
AmBev is 55.7% owned by InBev, and is part of the InBev group of companies. InBev is currently the world’s largest platform for beer sales, and AmBev is in charge of operations in South, Central and North America (excluding Cuba and the United States).
 
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Since the merger of CBB into AmBev on May 31, 2005, AmBev conducts the bulk of its operations in Brazil directly. It is also the indirect holding company for Labatt, the operations of HILA-ex and our stake in Quinsa and QIB. The following chart illustrates the ownership structure of AmBev’s principal subsidiaries as of May 31, 2005 on total share capital owned. For a list of our material subsidiaries, see Exhibit 8.1 to this annual report.
 
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chart
 
 
Property, Plant and Equipment
 
Our properties consist primarily of brewing, malting, bottling, distribution and office facilities in Argentina, Brazil, Canada, the Dominican Republic, Ecuador, Guatemala (from which we also serve the beer markets of El Salvador and Nicaragua), Paraguay, Peru, Uruguay, Venezuela and Quinsa’s brewing, malting, bottling, distribution and office facilities in Argentina, Bolivia, Paraguay and Uruguay. In May 2005, our beer plant in the metropolitan region of Lima, Peru, started operations, and we currently have one beer plant under construction in the Dominican Republic, which is expected to start operations in the fourth quarter of 2005. The capital expenditure requirements to finalize the plant in the Dominican Republic are estimated at R$90.8 million. Additionally, in 2005 we closed one brewer in New Westminster, British Columbia, Canada, and we have announced the closing of our brewery in Toronto, Ontario, Canada.
 
In 2004, our aggregate beer and soft drink production capacity was 158.1 million hectoliters per year. Our total annual beer production capacity was 114.2 million hectoliters. Our total soft drink production capacity was 43.9 million hectoliters.  These figures do not include facilities operated by Quinsa.
 
 
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The following is a list of our principal production facilities (excluding facilities operated by Quinsa):
 

Brazil
 
HILA-ex
 
North America
 
Plant
   
Type
of Plant
   
Plant
   
Type
of Plant
   
Plant
   
Type
of Plant
 
Agudos, São Paulo
   
Beer
 
 
CACN, Venezuela
 
 
Beer
 
 
St. John’s
 
 
Beer
 
Brasília, Federal District
   
Beer
 
 
Cerveceria Rio, Guatemala
 
 
Beer
 
 
Halifax
 
 
Beer
 
Curitiba, Paraná
   
Beer
 
 
Cerveceria Suramericana, Ecuador
 
 
Beer
 
 
Montreal
 
 
Beer
 
Equatorial, Maranhão
   
Beer
 
 
Huachipa, Peru
 
 
Beer
 
 
London
 
 
Beer
 
Estrela, Rio Grande do Sul
   
Beer
 
 
 
 
 
 
 
 
Toronto(42)
 
 
Beer
 
Goiânia, Goiás
   
Beer
 
 
Embodom, Dominican
Republic(1)
 
 
Mixed
 
 
Edmonton
 
 
Beer
 
Jacareí, São Paulo
   
Beer
               
Creston
   
Beer
 
Lages, Santa Catarina
 
 
Beer
 
 
Lima, Peru(2)
 
 
Soft Drinks
 
 
New Westminster(53)
 
 
Beer
 
Montenegro, Rio Grande do Sul
 
 
Beer
 
 
Sullana, Peru
 
 
Soft Drinks
 
 
 
 
 
 
 
Natal, Rio Grande do Norte
 
 
 
Beer
 
 
Barranca, Peru(3)
 
 
Soft Drinks
 
 
 
 
 
 
 
Aguas da Serra, São Paulo
 
 
 
Beer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cympay, Uruguay
 
 
Malt
 
 
 
 
 
 
 
Águas Claras, Sergipe
 
 
Mixed
 
 
MUSA, Uruguay
 
 
Malt
 
 
 
 
 
 
 
Aquiraz, Rio Grande do Norte
 
 
Mixed
 
 
Maltería Pampa, Argentina
 
 
Malt
 
 
 
 
 
 
 
Camaçari, Bahia
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Cebrasa, Goiás
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Cuiabá, Mato Grosso
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Jaguariúna, São Paulo
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Jacarepaguá, Rio de Janeiro
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
João Pessoa, Paraíba
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Nordeste, Pernambuco
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Nova Rio, Rio de Janeiro
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Manaus, Amazonas
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Minas, Minas Gerais
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Teresina, Piauí
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
Águas Claras do Sul, Rio Grande do Sul
 
 
Mixed
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Curitibana, Paraná
 
 
Soft drinks
 
 
 
 
 
 
 
 
 
 
 
 
 
Contagem, Minas Gerais
 
 
Soft drinks
 
 
 
 
 
 
 
 
 
 
 
 
 
Jundiaí, São Paulo
 
 
Soft drinks
 
 
 
 
 
 
 
 
 
 
 
 
 
Sapucaia, Rio Grande do Sul
 
 
Soft drinks
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Manaus, Amazonas
 
 
Crown Cap
 
 
 
 
 
 
 
 
 
 
 
 
 
Manaus, Amazonas
 
 
Concentrate
 
 
 
 
 
 
 
 
 
 
 
 
 
Maltaria Navegantes, Rio Grande do Sul
 
 
Malt
 
 
 
 
 
 
 
 
 
 
 
 
 
_____________
 
(1)
The Embodom plant’s beer line is currently under construction.
(2)
The Toronto brewery will be closed in the second half of 2005 as part of a production rationalization plan.
(53)
The New Westminster brewery was closed in the first half of 2005 as part of a production rationalization plan.
 
 
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Operating and Financial Review and Prospects
 
OPERATING RESULTS
 
Introduction
 
This section contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors including, without limitation, those set forth in “Cautionary Statement Regarding Forward-Looking Information” and the matters set forth in this annual report generally.
 
We have prepared our audited consolidated financial statements as of December 31, 2004, 2003 and 2002 and for the three years ended December 31, 2004 in Brazilian Reais in accordance with Brazilian GAAP, which differs in certain significant respects from U.S. GAAP. The audited financial statements included elsewhere in this annual report have been prepared in accordance with Brazilian GAAP and include a reconciliation of net income and shareholders’ equity to U.S. GAAP, a discussion of the reconciling differences in accounting principles, and the presentation of the U.S. GAAP condensed balance sheets and statements of operations in Brazilian reais.
 
AmBev’s discussion and analysis of its financial condition and results of operations are based upon its primary financial statements. As a result, the financial information and related discussion and analysis contained in this Item are in accordance with Brazilian GAAP and figures are in reais, unless otherwise stated.
 
Critical Accounting Policies
 
Critical accounting policies are those that are both important to the portrayal of our financial condition and results and require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the possible future resolution of the uncertainties increase, those judgments become even more subjective and complex. In order to provide an understanding about how our management forms its judgments about future events, including the variables and assumptions underlying the estimates, and the sensitivity of those judgments to different circumstances, we have identified the following critical accounting policies:
 
·  
Goodwill, Intangible Assets and Amortization
 
·  
Pensions, Employee Benefits and FAHZ Net assets
 
·  
Contingencies
 
·  
Deferred tax
 
·  
Accounting for derivatives
 
Goodwill, Intangible Assets and Amortization
 
We have made acquisitions that included a significant amount of goodwill and other intangible assets, including the acquisition of Labatt Brewing Company Limited, a corporation organized under the federal laws of Canada, on August 27, 2004. The accounting for goodwill and intangible assets under Brazilian GAAP remains unchanged, with goodwill amortized over defined finite periods, as disclosed in note 2(k) to our financial statements.
 
Under Brazilian GAAP, net goodwill was R$18,170.4 million and R$1,687.3 million at December 31, 2004 and 2003, respectively. This was net of accumulated amortization of R$4,779.1 million and R$689.6 million, respectively, and negative goodwill of R$175.1 million and R$176.9 million, respectively. The amortization charge for the purposes of Brazilian GAAP was R$803.6 million for the year ended December 31, 2004 and R$252.4 million for the year ended December 31, 2003.
 
Under U.S. GAAP, net goodwill was R$13,418.9 million and R$253.5 million at December 31, 2004 and 2003, respectively. SFAS No. 142, “Goodwill and Other Intangible Assets,” became effective for acquisitions after
 
45

 
June 30, 2001. This standard requires that goodwill no longer be amortized but tested annually for impairment, and we therefore ceased to amortize goodwill as from January 1, 2002. The amortization expense under U.S. GAAP related to goodwill was nil for the years ended December 31, 20022003 and 2004. Our intangible assets with definite useful lives continue to be amortized over the estimated useful lives of these assets.
 
Our goodwill was grouped into reporting units and tested for impairment in 2004, 2003 and 2002 under the guidance of SFAS No. 142. Reassessment of lives of all intangible assets and specific tests for impairment of intangible assets with finite lives will continue to be performed annually to determine the need for impairment provisions and whenever events or changes in circumstances indicate that its carrying value may not be recoverable. Factors which could trigger an impairment adjustment include the following:
 
·  
significant underperformance relative to expected historical or projected future operating results of reporting units,
 
·  
significant changes in the manner we used the acquired assets or the strategy for our overall business or use of trade names, or
 
·  
significant negative industry or economic trends.
 
During 2004, as a result of the decision from the Brazilian antitrust authorities that AmBev must sell its Marathon brand, we recorded an impairment provision totaling R$26.1 million. No goodwill impairment existed at December 31, 2003 and 2002.
 
Employee Benefits and the FAHZ Net Assets
 
The FAHZ, one of AmBev’s controlling shareholders, provides medical, dental, educational and social assistance to our current and retired employees, as well as their beneficiaries and dependents, as discussed in note 13 (c) to the audited financial statements included elsewhere in this report. Prior to the combination with Antarctica, Brahma also provided the same benefits through the Brahma Welfare Foundation (“BWF”). The assets of BWF were merged into the FAHZ on October 27, 2000 and the former ceased to exist.
 
AmBev can contribute up to 10% of its consolidated net income to support the FAHZ. At December 31, 2004, the FAHZ owned 16.1% of AmBev’s outstanding voting shares and 7.8% of AmBev’s total outstanding shares. See “Major Shareholders and Related Party Transactions”.
 
Brazilian GAAP Accounting
 
The FAHZ, which provides medical and other post-retirement benefits to our employees in Brazil, is a legally distinct entity for the purposes of Brazilian GAAP. Under Brazilian GAAP, we do not include the assets and liabilities of the FAHZ within our financial statements.
 
Under Brazilian GAAP, we account for all benefit obligations provided by us, including those in relation to the FAHZ, in accordance with the IBRACON Accounting Standard and Procedure NPC No. 26, “Pensions and Post-retirement benefits”. This standard requires the comprehensive recording of pension obligations and expenses on an actuarial basis. We elected pursuant to NPC No. 26 to reduce shareholders’ equity at December 31, 2001 to reflect the accumulated obligation for the actuarial liability due to the FAHZ by R$40.6 million (R$61.5 million, net of R$20.9 million deferred tax). We also recorded against our shareholder’s equity the liability related to the benefits which we provide directly to our employees, totaling R$36.7 million (R$55.6 million, net of R$18.9 million deferred tax), on December 31, 2001. Prior to the implementation of NPC No. 26, for the year ended December 31, 2000, AmBev expensed all pension and post-retirement contributions, including those made by AmBev to the FAHZ, directly to the statement of operations on an accrual basis without recognition of the actuarial obligation. From January 1, 2002, we recognized in income a charge to pensions and post-retirement benefits to reflect the change in the actuarial obligation, less the fair value of plan assets and the effect of deferrals.
 
Plan assets of the AmBev Pension Fund (“IAPP”) include amounts contributed by AmBev and its employees and amounts earned from investing the contributions, less benefits paid. Following an actuarial review of the defined benefits plan which had been closed to new participants, the net assets at December 31, 2004 were
 
46

 
considered to be in excess of that required to meet the projected benefit obligation. Although AmBev will reduce future employer contributions to the minimum permitted by law, Brazilian pension regulations currently provide no means for returning this surplus to the sponsor. In view of this uncertainty, on December 31, 2004, AmBev included in the actuarial determination of the pension obligation at December 31, 2004 and 2003 a valuation allowance of R$195.2 million and R$167.1 million against the plan assets. This allowance affected the pension charge/benefit as from 2003.
 
U.S. GAAP Accounting
 
Under U.S. GAAP, the net assets of the FAHZ, excluding the actuarial liability and its operating expenses, are included in the determination of shareholders’ equity and net income of AmBev, as such assets are not considered to be plan assets as defined by SFAS No. 106, “Employers’ Accounting for Post-retirement Benefits Other than Pensions”, since they are not segregated and restricted between active and retired employees.
 
Under U.S. GAAP, we account for post-retirement benefits in accordance with SFAS No. 106 “Employees Accounting for Post-retirement Benefits and Other Obligations”. We have recorded an accrued liability, based on independent actuarial reports at the end of each period, for the retirement element of the obligations applicable to the FAHZ.
 
Several statistical data and other factors which attempt to anticipate future events are used in calculating the expense and liability related to our pension and employee benefit plans. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by us, within certain guidelines. In addition, our actuarial consultants also use subjective factors, such as withdrawal, turnover and mortality rates. The actuarial assumptions we use may differ materially from our actual results, due to changing market and economic conditions, regulatory events, judicial rulings, higher or lower withdrawal rates or longer or shorter life spans of participants.
 
Contingencies
 
The preparation of our financial statements requires our management to make estimates and assumptions regarding contingencies which affect the valuation of assets and liabilities at the date of the financial statements and the revenues and expenses during the reported period. The most significant of these are as follows:
 
Legal contingencies
 
We are currently involved in certain legal proceedings, as discussed in “Financial Information—Consolidated Financial Statements and Other Financial Information—Legal Proceedings”. In the future, management may make decisions which impact the structure, operations, and staffing of the company, which may result in further claims. Fundamental changes in economic conditions may also result in similar restructuring strategies. We have recorded liabilities on pending litigation based on the advice of external legal counsel and on estimates of the amounts and the range of the losses. Unless impacted by changes in accounting standards and practices, we intend to continue to record these liabilities in the same manner, based on our assessment of the exposures at that time. However, our assumptions and estimates may change in the future based on our assessment of any given situation, which may result in changes in future provisioning for legal claims.
 
Labor claims
 
Management is required to make estimates of the potential losses on outstanding labor claims based on the advice of external legal counsel on the likelihood of successful outcome. When external counsels advise us that it is probable that our case will not prevail we record provisions against these exposures based on estimated loss amounts. Brazilian employment and labor legislation is extensive and complex, giving rise to many claims from current and former employees against us or our subsidiaries. These claims relate principally to overtime, dismissals, severance,
 
47

 
health and safety, supplementary retirement benefits and other matters.
 
Tax contingencies
 
The complexity of the Brazilian corporate fiscal environment often results in disputes over a number of different taxes. We are currently involved in certain tax proceedings and have filed claims to avoid payment of taxes that we do not believe are constitutional. As discussed in note 13 to our financial statements, we have accrued the costs for the resolution of the losses when we consider loss of our claim to be probable. The tax contingencies relate primarily to value-added sales and excise taxes, taxes on revenue and income taxes and are described in detail in the financial statements. The estimates are developed based on the advice of external legal counsel and upon an analysis of potential results. We do not believe these proceedings will have a material adverse effect on our financial position. It is possible, however, that future results of operations could be materially affected by changes in our assumptions, and the effectiveness of our strategies with respect to these proceedings.
 
Unrecognized exposures
 
Brazilian GAAP and U.S. GAAP require us to provide for every legal or tax claim on the balance sheet which we consider loss to be probable. We have estimated the total exposures of possible losses, which are not recorded as liabilities, to be R$1,241.1 million at December 31, 2004. In addition, during the first quarter of 2005, we received a number of assessments from Brazilian tax authorities relating to earnings of our foreign subsidiaries, in the total amount of approximately R$3 billion. Based on the advice of external counsel, we believe that such assessments are without merit and, accordingly, we have not recorded any provision in connection therewith. We have estimated the total exposures of possible (but not probable) losses, which are not recorded as liabilities, to be of approximately R$2 billion in connection with those assessments, and the remaining is estimated to be a remote loss. We believe that our estimates are based on reasonable assumptions and assessments of external legal counsel, but should the worst case scenario develop, subjecting us to losses in all cases, our net impact on the statement of operations would be an expense for this amount.
 
Deferred tax
 
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of our assets and liabilities. We regularly review the deferred tax assets for recoverability and will only recognize these if we believe that it is probable (under Brazilian GAAP) or more-likely-than not (under U.S. GAAP) that there will be sufficient taxable profit against any temporary differences that can be utilized, based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. Pursuant to CVM regulations, under Brazilian GAAP, we must demonstrate that we will recover the tax assets discounted to present value based on expected realization dates, within a 10-year period, even though these credits have no prescription period for Brazilian tax law purposes.
 
In the event we or one of our subsidiaries operate at a loss or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we evaluate the need to establish a valuation allowance against all or a significant portion of our deferred tax assets resulting in an increase in our effective tax rate.
 
We do not record deferred tax liabilities on the earnings generated by our foreign subsidiaries. Based on the advice of external counsel, we concluded that these earnings are not taxable on remittance to Brazil. The Brazilian fiscal authorities introduced new legislation in the third quarter of 2001 to, among other measures, subject offshore earnings to income tax in Brazil from December 31, 2002, regardless of whether earnings have been remitted to Brazil. We continue to believe that the current tax initiatives that we are undertaking will not result in taxes on these earnings, based on the advice of external counsel and we have not therefore recorded a liability for such taxes in our financial statements.
 
As part of the 1997 Pepsi transaction, we acquired the conditional right to certain tax assets. Had we utilized the assets within the period which expired in October 2002, 80% of the benefit would have been returned to the seller. Under Brazilian GAAP and U.S. GAAP, we recognized 20% of the tax asset at the time of the acquisition and recorded a valuation allowance against the 80%. During 2002, as we were confident that it was more likely than not that the further 80% would be recovered under U.S. GAAP, we recorded a tax benefit of R$148.0 million in 2002 to reflect the tax loss carry forwards no longer subject to contingent utilization. This amount was taken directly as a benefit to the statement of operations under U.S. GAAP, as opposed to an increase in the goodwill of the Pepsi transaction, to reflect the lifting of the restrictions which placed recoverability in doubt. We did not record the tax
 
 
48

 
asset equivalent to 80% of the available tax losses under Brazilian GAAP until 2003, after we met the more stringent rules of the CVM.
 
Certain other tax assets arising from the Brazilian GAAP purchase accounting adjustments at the time of the Brahma and Antarctica combination and the subsequent downstream merger of Antarctica have not been recorded as recovery is not presently considered probable.
 
Accounting for derivatives
 
Brazilian GAAP Accounting
 
We enter into foreign currency forward, swap and future contract agreements (principally for U.S. dollars) to mitigate foreign exchange risk on U.S. dollar-denominated debt, financing of imports and payables to foreign suppliers. These agreements are marked-to-market and recorded at the lower of cost plus interest and market value. The unrealized gains and losses on these financial instruments are reported in the statement of operations and included in “Financial income” and “Financial expenses”.
 
Brazilian GAAP requires us to disclose the fair value of financial instruments at the balance sheet date but does not require us to record the unrealized marked-to-market fair value gains in income in the year. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. In summary, the accounting adjustments made to reflect our derivative operations generally fall into one of the following three categories:
 
 
(i)
Financial instruments utilized to mitigate commodity price and foreign currency risk related to programmed purchases of raw materials are recorded at cost plus accrued interest with the corresponding realized and unrealized gains or losses recognized in inventories. Gains and losses on purchases for which we have not yet taken delivery are included in other assets. Gains and losses are recognized in our results as “Cost of sales” when the corresponding products are sold. When these instruments are effected to mitigate operating expenses the results are recorded in the corresponding accounts.
 
 
(ii)
Other financial instruments utilized to manage foreign currency cash flow exposure are recorded at the lower of cost or market and the realized and unrealized gains and losses on these financial instruments are reported in the statement of operations as Financial income and Financial expenses.
 
 
(iii)
In the event we decide to cancel the effect of the swaps, we at times enter into contracts with corresponding offsetting positions, with an identical value at maturity, and settlement date and restatement index. This procedure is more cost efficient than entering into new hedge contracts. These financial instruments are measured and recorded based on the lower of fair value or cost plus accrued interest (the “yield curve”).
 
Commodities
 
Financial instruments used to mitigate commodity price risk are recorded at cost plus accrued interest. Unrealized losses at December 31, 2004 on outstanding contracts totaled R$45.3 million and will be recognized in the statement of operations when the products are sold. Realized gains on commodity contracts closed during 2004 amounted to R$8.3 million and these were recognized as Cost of Sales in the statement of operations to match the associated commodity currency cost.
 
Interest and Foreign Currencies
 
The fair values of these financial assets provide a shelter for the currency and interest rate risks accruing from the financial liabilities. Although the Company’s intention is to maintain these assets, they could be realized at the Company’s discretion. Should these instruments be settled only on their respective maturity dates, the negative effect between the market value and estimated yield curve of the instruments would be totally eliminated. Had the
 
49

 
Company been able to adopt the same criterion to recognize its financial liabilities at market value, it would have presented an unrealized pre-tax loss of approximately R$602.6 million at December 31, 2004 as follows:
 
Financial liabilities
   
Book value
   
Fair value
   
Unrealized gain
(loss
)
                     
Notes
   
R$2,701.1
   
R$3,265.7
   
R$(564.6
)
C$ Labatt Series A Notes
   
434.2
   
466.1
   
(31.9
)
U.S.$ Labatt Series B Notes
   
111.7
   
117.8
   
(6.1
)
   
R$3,247.0
   
R$3,849.6
   
R$(602.6
)

U.S. GAAP Accounting
 
All derivative financial instrument agreements not designated as hedges are marked-to-market and the realized and unrealized gains and losses on these financial instruments used to manage foreign currency exposures are reported in the statement of operations and included in “Financial income” and “Financial expenses”.
The Company believes that swap quotations obtained are reasonable when compared with information on similar financial instruments traded in the Bolsa de Mercadorias & Futuros (“BM&F”) and that the internally developed valuation methodology is consistent with methodologies used by other participants in the swap market in Brazil and its results reasonably reflect the amount that would be paid or received to settle the swap on the valuation date.
 
Intense volatility in the foreign exchange and interest rate markets in Brazil observed during 2002 has caused significant changes in forward rates and interest rates over very short periods of time, generating significant changes in the fair value of such cross-currency interest rate swaps over such periods.
 
Consolidation of less than majority owned subsidiaries
 
Under Brazilian GAAP, we record joint-ventures, including investees in which we share control through our participation in a stockholders’ agreement under the proportional consolidation method.
 
For purposes of U.S. GAAP, the subsidiaries that are accounted for under Brazilian GAAP on a proportional consolidation basis are recorded as equity in affiliates under the equity method of accounting.
 
We do not have any variable interest entities at December 31, 2004 which would be required to be consolidated under the provisions of FASB’s Financial Interpretation Fin 46-R “Consolidation of Variable Interest Entities (revised December 2003)”.
 
U.S. GAAP Reconciliation
 
Our net income in accordance with Brazilian GAAP was R$1,161.5 million in 2004, R$1,411.6 million in 2003 and R$1,510.3 million in 2002. Under U.S. GAAP, we would have reported net income of R$1,392.0 million in 2004, R$1,689.4 million in 2003 and R$1,642.2 million in 2002.
 
Our shareholders’ equity in accordance with Brazilian GAAP was R$16,955.9 in 2004, R$4,308.2 million in 2003 and R$4,129.6 million in 2002. Under U.S. GAAP, we would have reported shareholders’ equity of R$17,720.3 in 2004, R$4,382.9 million in 2003 and R$3,960.6 million in 2002.
 
The principal differences between Brazilian GAAP and U.S. GAAP that affected our net income in 2002, 2003 and 2004, as well as shareholders’ equity at December 31, 2002, 2003 and 2004, relate to the treatment of the following items:
 
·  
Under Brazilian GAAP, the combination of the two predecessor companies Brahma and Antarctica was accounted for as a merger at a book value; for the purposes of U.S. GAAP, the transaction was treated as an acquisition by Brahma of Antarctica at fair market value;
 
 
50

 
 
·  
Under Brazilian GAAP, goodwill arises from the difference between the amount paid and the book value of the net assets acquired. Under U.S. GAAP, fair values are assigned to assets, call option and liabilities assumed in business combinations, including intangible assets and unallocated goodwill. Non-cash consideration paid under U.S. GAAP, when the consideration includes assets contributed, shares and put options, is determined based on fair values. The changes in the fair value of the BAC put option were recorded in income;
 
·  
Under Brazilian GAAP inflation accounting was discontinued effective January 1, 1996. Prior to that date, Brazilian GAAP statements included indexation adjustments which partially accounted for the effect of inflation on property, plant and equipment, investments, deferred charges and shareholders’ equity, and reported the net charge or credit in the statement of operations; for the purposes of U.S. GAAP, Brazil ceased to be treated as a highly inflationary economy only as from January 1, 1998. Therefore the financial information for purposes of U.S. GAAP for the two-year period ended December 31, 1997 includes additional inflation restatement adjustments made by applying the IGP-M to permanent assets and shareholders’ equity. This results in additional depreciation charges as at December 31, 2004, 2003 and 2002;
 
·  
The net assets of FAHZ, which provides medical, dental, educational and social assistance to current and former employees, have been included in our consolidated financial statements for the purposes of U.S. GAAP because the plan assets are not segregated between current and retired employees. Under Brazilian GAAP, we have not included the FAHZ. See “Critical Accounting Policies—Employee Benefits and the Consolidation of the FAHZ”;
 
·  
Under Brazilian GAAP, certain contractual tax related assets arising from the Pepsi transaction in 1997 were recognized in 2003 when probability of recovery was assured; for purposes of U.S. GAAP in 2002 when realization was considered more likely than not, we reversed a tax valuation allowance benefiting earnings as most of the intangible assets in respect of the Pepsi transaction had been amortized;
 
·  
Under Brazilian GAAP, advances to employees for purchase of shares are recorded as an asset and the interest accrued credited to income. Under U.S. GAAP, as the advances are collateralized by the stock issued under the stock ownership plan, the loan is reported as a deduction from shareholders’ equity;
 
·  
Under Brazilian GAAP, prior to December 31, 2001, the expenses related to pension plans and other post-retirement benefits were recognized on an accrual basis only to the extent of required contributions for the relevant year or financial period. These expenses were fully recorded on an actuarial basis under U.S. GAAP. A valuation reserve recorded against surplus plan assets under Brazilian GAAP was reversed for purposes of U.S. GAAP for all periods;
 
·  
Under Brazilian GAAP, financing charges from borrowings used in construction were not capitalized prior to 1996; for the purposes of U.S. GAAP, capitalization of the interest expense on borrowed funds, excluding foreign exchange losses, during construction of major facilities is recognized as part of the cost of the related assets;
 
·  
Under Brazilian GAAP, the rights to acquire AmBev’s shares granted to employees, officers and directors under the stock ownership plan do not result in any expense being recorded. Under U.S. GAAP, in accordance with APB 25, Accounting for Stock Issued to Employees, the rights to acquire AmBev’s shares granted under the stock ownership plan is deemed to give rise to compensation expense to the extent of the excess market price of the shares over the purchase price to employees, officers and directors;
  
·  
Under Brazilian GAAP, foreign exchange gains or losses arising from the translation of foreign subsidiaries and investees to the real are recorded in earnings. For purposes of U.S. GAAP, these translation gains and losses are recorded as cumulative translation adjustments in other comprehensive income.
 
51

 
·  
Under Brazilian GAAP, dividends proposed by management are required to be accrued in our financial statements; for the purposes of U.S. GAAP, these may not be accrued until ratified by a shareholders’ meeting;
 
·  
Under Brazilian GAAP, goodwill is amortized; for purposes of U.S. GAAP, beginning on January 1, 2002, goodwill is no longer amortized but tested annually for impairment;
 
·  
There are a number of expenses and charges which can be capitalized and deferred under Brazilian GAAP, which are expensed under U.S. GAAP; and
 
·  
Under Brazilian GAAP, certain derivative instruments are recorded at the lower of cost plus accrued interest and fair market value. Under U.S. GAAP, SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities requires that an entity recognize all derivatives as either assets or liabilities and measure those instruments at fair value. As these transactions do not meet the requirements to qualify for hedge accounting under SFAS No. 133, unrealized gains are recorded in our results of operations under U.S. GAAP.
 
Our audited financial statements included elsewhere in this report provide for a fuller description of these differences and a reconciliation of net income and total shareholders’ equity from Brazilian GAAP to U.S. GAAP.
 
Accounting Aspects and Impact of the Quinsa Transaction
 
      The acquisition of our interest in Quinsa, consummated on January 31, 2003, is reflected in our consolidated financial statements for the years ended December 31, 2003 and December 31, 2004.
 
Under Brazilian GAAP we record our interest on the net assets and financial results of Quinsa based on the proportional consolidation method (i.e. line-by-line). For U.S. GAAP purposes our interest in Quinsa is accounted for under the equity method beginning the year ending December 31, 2003.
 
Quinsa is a SEC registered entity and files its financial statements prepared in U.S. dollars under Luxembourg GAAP with a reconciliation of shareholders’ equity and net income (loss) to U.S. GAAP.
 
On January 31, 2003, we acquired 37.5% of the total capital of Quinsa from BAC and Quinsa and 8.6% of the shares of QIB from Heineken. Quinsa owned at that time 85.0% of QIB. As a result, at January 31, 2003, we had a total 40.475% economic interest in Quinsa. During 2003, we acquired an additional 12.0 million Class B shares of Quinsa in the open market, increasing our total economic interest in Quinsa to 47.99% at December 31, 2003. As Quinsa has repurchased some of its own shares during 2004, our economic interest increased to 54.8% as of December 31, 2004. As of May 2005, our total economic interest in Quinsa increased to 55.2%. AmBev and BAC are parties to a shareholders’ agreement whereby each shareholder exercises 50% control over the operations of Quinsa and its subsidiaries. Accordingly, under Brazilian GAAP, Quinsa has been since January 31, 2003 proportionally consolidated and under U.S. GAAP, Quinsa has been accounted for under the equity method. For further details on the acquisition, the business of Quinsa and antitrust matters, refer to “Information on the Company—AmBev Business Overview—Acquisition of Interest in Quinsa.”
 
In order to provide comparable data to demonstrate the impact of the acquisition of our interest in Quinsa on our results and trends in 2003 and 2004, we have included in the tables below certain key financial indicators as at December 31, 2003 and 2004 and the combination of those balances with the AmBev balances before and after the proportional consolidation of Quinsa. Our consolidated financial statements, prepared under Brazilian GAAP, included our investment in Quinsa on a proportional consolidation basis (i.e. line-by-line).
 
52

 
Statement of operations
 
February-
December 2003
Year ended
Year ended
(Brazilian GAAP)
   
100% of
Quinsa
   
AmBev’s
Share(1)(2)
 
 
AmBev
without
Quinsa(3)
 
 
AmBev
consolidated
   
AmBev
without
Quinsa(3)
 
 
AmBev
consolidated
 
(R$ in millions)
                                       
Gross Sales
   
2,542.4
   
1,125.1
   
16,018.4
   
17,143.5
   
21,599.2
   
23,297.6
 
Net Sales
   
1,745.5
   
773.7
   
7,910.1
   
8,683.8
   
10,859.8
   
12,006.8
 
Cost of Sales
   
(882.4
)
 
(387.3
)
 
(3,656.9
)
 
(4,044.2
)
 
4,276.2
   
(4,780.5
)
Gross Profit
   
863.1
   
386.4
   
4,253.1
   
4,639.6
   
6,583.6
   
7,226.3
 
Operating Income(4)
   
382.3
   
175.8
   
1,789.1
   
1,964.9
   
1,778.1
   
2,163.3
 
Net Income
   
316.5
   
149.7
   
1,261.9
   
1,411.6
   
884.9
   
1,161.5
 
 
  
Balance Sheet
 
(Brazilian GAAP)
   
100% of
Quinsa
   
AmBev’s
Share(1)(2)(5
)
 
AmBev
without
Quinsa(3
)
 
AmBev
consolidated
   
AmBev
without
Quinsa(3
)
 
AmBev
consolidated
 
 
(R$ in millions)
 
                                       
Current assets
   
861.0
   
427.6
   
5,072.9
   
5,500.5
   
4,960.8
   
5,379.6
 
Long term assets
   
439.6
   
132.4
   
2,974.3
   
3,192.6
   
3,363.9
   
3,606.5
 
Permanent assets
   
2,328.5
   
1,156.3
   
4,980.7
   
6,137.0
   
22,892.4
   
24,030.4
 
                                       
Short term borrowings
   
298.3
   
148.1
   
1,828.0
   
1,976.1
   
3,283.6
   
3,443,1
 
Other short term liabilities
   
477.8
   
237.3
   
2,506.6
   
2,743.9
   
5,051.7
   
5,328.6
 
                                       
Long term borrowings
   
684.1
   
339.7
   
3,664.6
   
4,004.3
   
4,000.5
   
4,367.6
 
Other long term liabilities
   
119.2
   
59.2
   
1,541.9
   
1,601.1
   
2,609.3
   
2,683.0
 
                                       
Minority Interest
   
402.0
   
199.6
   
(3.2
)
 
196.4
   
(3.3)
   
198.3
 
Shareholders’ equity
   
1,647.7
   
818.2
   
3,490.0
   
4,308.2
   
16,275.3
   
16,995,9
 
 
                                     
_____________________
(1)
For the purposes of U.S. GAAP, we report our interest in Quinsa on an equity accounting basis and not on a proportional consolidation basis.
(2)
Represents our economic interest in Quinsa during the eleven months from January 31, 2003 through December 31, 2003.
(3)
Net of adjustments arising from proportional consolidation of Quinsa.
(4)
Operating income under Brazilian GAAP is presented after financial income and financial expenses.
(5)
Represents our economic interest in Quinsa at December 31, 2003.
 
Quinsa carries out a significant portion of its business in Argentina. Since the fourth quarter of 1998, the Argentine economy has been in a recession, and during the second half of 2001, the recession worsened significantly, precipitating a political and economic crisis. Changes to Argentine law in connection with the economic crisis in Argentina have had a significant impact on Quinsa’s operations. As a result, historical financial statements are not indicative of Quinsa’s current financial position or anticipated results of operations or business prospects, all of which have been materially and adversely affected by the economic crisis since December 31, 2001. Further information is available in Quinsa’s annual report on Form 20-F for the fiscal year ended December 31, 2004 to be filed with the SEC. Documents filed by Quinsa with the SEC, including its 2004 Annual Report and any information therein, are not incorporated by reference in this annual report.
 
At December 31, 2003, a substantial portion of the financings incurred by Quinsa’s subsidiaries in Argentina was denominated in U.S. dollars. The devaluation of the Argentine Peso and the economic crisis in Argentina, mainly in 2002, restricted the ability of these subsidiaries to generate sufficient cash flows to meet the
 
53

 
obligations falling due on the dates originally determined for liabilities denominated in foreign currency. The management of Quinsa and its subsidiaries renegotiated the maturity terms with financial institutions. At December 31, 2004, a substantial portion of these financings continue to be denominated in U.S. dollars.
 
As of December 31, 2004, we reclassified U.S.$4.7 million (U.S. $4.3 million in 2003) of Quinsa’s long-term debt, with respect to which Quinsa was not in compliance with certain covenants, to current liabilities. See—Liquidity and Capital Resources—Long-term Debt.”
 
Accounting Aspects and Implications of the Labatt Acquisition
 
The acquisition of our interest in Labatt was consummated on August 27, 2004, with the merger of Mergeco, the holding company of Labatt,  into AmBev.  The balance sheet data of Labatt as at December 31, 2004 was fully consolidated into our audited financial statemetns as at December 31, 2004, and will continue to be fully consolidated for future periods.  The results of operations for Labatt were fully consolidated for the period from August 27, 2004 until December 31, 2004 in our audited consolidated financial statements, and will continue to be fully consolidated for future periods.  The total amount of the acquisition, R$ 14,441.0 million was recorded in our financial statements as a pooling of interests with the following entries:  (i) increase of AmBevs capital stock by R$ 1,600.7 million; and (ii) increase of additional paid-in capital, a capital reserve, by R$ 12,840.3 million.  See notes 1(ii), 7, 8 of our audited consolidated financial statements for more information.
 
Under U.S. GAAP, we acccounted for the transaction using the purchase method of accounting with AmBev as the accounting acquirer. We accounted for this transaction as if AmBev had acquired Labatt Canada directly in order to determine the amount of goodwill to be recorded by AmBev. The U.S. GAAP accounting was based on the substantive participating rights that FAHZ enjoys under the AmBev Shareholders' Agreement.
 
The purchase consideration of R$14,243.8 million was determined based on the fair value of the shares issued by AmBev at March 3, 2005, which was considered to be the measurement date for this transaction. Goodwill arising from the acquisition of Labatt under U.S. GAAP totaled R$12,950.5 million and was determined as the excess of the purchase consideration over the fair value of the net assets acquired.
 
In order to provide a better understanding of the impact of the acquisition of our interest in Labatt financial statements as of and for the year ended December 31, 2004, we have included in the tables below certain key financial indicators as at December 31, 2004 and the consolidation of those balances with the AmBev balances.
 
 
Assets
   
AmBev
   
Labatt ApS
   
Combined
   
Eliminations
   
Consolidated
 
                                 
Current assets
   
4,299.6
   
1,083.0
   
5,382.6
    (2.9  
5,379.7
 
Non-current assets
   
3,350.2
   
256.3
   
3,606.5
         
3,606.5
 
Goodwill on the acquisition of companies, net
   
1,668.0
   
16,502.4
   
18,170.4
         
18,170.4
 
Property, plant and equipment
   
4,291.6
   
1,240.1
   
5,531.7
         
5,531.7
 
Other permanent assets
   
15,602.9
   
25.9
   
15,628.8
   
(15,300.6
)
 
328.2
 
Total assets
   
29,212.3
   
19,107.8
   
48,320.0
   
(15,303.5
 
33,016.5
 

Liabilities
   
AmBev
   
Labatt ApS
   
Combined
   
Eliminations
   
Consolidated
 
                                 
Loans and financings
   
1,531.4
   
1,911.7
    3,443.1           
3,443.1
 
Other current liabilities
     4,058.4     1,273.1      5,331.5      (2.9  
5,328.6
 
Current liabilities
     5,589.8    
3,184.8
    8,774.6       (2.9  
8,771.7
 
Long-term loans and financings
     3,629.9    
737.7
    4,367.6           
4,367.6
 
Accrued liability for contingencies
     1,471.0           1,471.0           
1,471.0
 
Provision for post-retirement benefits
     78.4    
567.6
    646.0             646.0  
Other long-term liabilities
     726.6      193.9     920.5       (156.2 )    764.3  
Shareholders’ equity (*)
     17,716.6    
14,423.7
    32,140.3      (15,144.4  
16,995.9
 
Total
     29,212.3    
19,107.8
    48,320.0       (15,303.5  
33,016.5
 

(*) An account receivable balance equivalent to R$ 268.7 was recorded on December 31, 2004. See note 1(ii) to our consolidated financial statements for more information.
 
 
54

 
Other Acquisitions/Dispositions and Accounting Implications
 
Industrias Del Atlántico
 
On October 24, 2002, AmBev and The Central America Bottling Corporation, or CabCorp, entered into a joint-venture agreement, setting forth rights and obligations for the creation of a strategic regional alliance to collaborate in, among other things, the production, importation, distribution, marketing and sale of AmBev’s products, especially beer in Guatemala, and other Central American countries. On August 12, 2003, Monthiers, an indirect subsidiary of AmBev, subscribed for 573,092 shares of common stock of Industrias del Atlántico S.A. (“IDA”), a Guatemalan company formerly controlled by CabCorp, representing 50% plus one share of the outstanding issued and outstanding common stock of IDA. As consideration, Monthiers contributed to IDA U.S.$7.2 million in debt of IDA relating to credits that CBB held against IDA. These credits had arisen from the importation by IDA of certain goods and equipment from CBB and that had been transferred to Monthiers.
 
Embodom
 
In February 2004, AmBev acquired 51% of capital stock of Embodom, located in the Dominican Republic, for approximately R$204.9 million, generating goodwill at the amount of R$173.4 million. In December 2004, AmBev recalculated the goodwill due to adjustments in the shareholders’ equity basis for the acquisition due to interest losses deriving from capitalizations made by AmBev and set forth in the acquisition agreement, resulting in an adjustment at the net amount of R$24.0 million.
 
Compañia Cervecera AmBev Peru S.A.C.
 
On October 31, 2003, through our subsidiary Companhia Cervecera AmBev Perú S.A.C., AmBev acquired certain assets of Embotelladora Rivera in Peru for approximately R$86.7 million. These assets include two soft drinks plants, which combined have an estimated production capacity of 6.3 million hectoliters per year, and other sales and distribution assets in Lima. Contemporaneously with this acquisition, AmBev became PepsiCo’s exclusive bottler for Northern Peru and Lima. Embotteladora Rivera will sell and distribute our beer and soft drinks products in Northern Peru. Our beer plant in Peru has been fully operational since May, 2005.
 
Cerveceria SurAmericana  (currently Compania Cervecera AmBev Ecuador S.A. (“AmBev Ecuador”))
 
In December 2003, we acquired 80% of the capital of AmBev Ecuador, located in Ecuador, for a total consideration of R$105.6 million, resulting in negative goodwill of R$18.5 million. 
 
Astra
 
During the months of June and July 2002, CBB, a then wholly-owned subsidiary of AmBev, increased its participation in the total capital of Astra from 73.1% to 93.6%, through the purchase of Águia S.A.’s stake in Astra. Through 2002, CBB purchased shares from minority shareholders and increased its participation in the total capital of Astra to 96.7%. The 2002 stock purchase consideration totaled R$128.5 million, including R$94.3 million of goodwill. During 2003, Astra was merged into CBB as part of our tax planning strategy, and a goodwill totaling R$146.3 million was reclassified to deferred charges for purposes of Brazilian GAAP. No such reclassification was made under U.S. GAAP.
 
IBANN
 
On November 1, 2001, the shareholders of AmBev and the minority shareholders of IBANN, a subsidiary of CBB (and a former Antarctica subsidiary), consummated a share exchange and approved the acquisition of the remaining interest (35.0%) in IBANN by AmBev. AmBev issued 526,210,199 shares, of which 96,712,635 were common shares and 429,497,564 were preferred shares in exchange for 17.1% and 45.4% of the common and preferred shares the minorities held in IBANN, and recorded a capital increase of R$298.3 million. On December 10, 2001, we announced that we would pay R$242.2 million to the minority shareholders of IBANN who exercised their appraisal rights in lieu of accepting the share exchange. Under Brazilian GAAP, we accounted for this as a separate transaction, in effect a share buy-back, and recorded it as an increase in treasury shares. Under Brazilian GAAP, no goodwill was recognized on this transaction, although a capital gain of R$18.2 million was
 
 
55

 
recognized in the statement of operations to reflect the difference in the net book value of the assets pertaining to the minority shareholders and the appraised book value calculated in the previous three months. For the purposes of U.S. GAAP, we believe that this transaction was inseparable from the acquisition itself and that the capital paid to IBANN minority shareholders was part of the consideration for the purchase.
 
Bavaria
 
On November 6, 2000, we entered into stock and distribution agreements providing for the sale of Bavaria S.A. to Molson Inc. See “Information on the Company—The Brahma Antartica Combination – Creation of AmBev and Brazilian Antitrust Approval”. The total contingent consideration for the sale was R$416.1 million, of which R$191.4 million was received at that time. The remaining R$224.7 million would be payable to us by Molson subject to the Bavaria brand reaching certain market share thresholds. We have not recorded this as an asset on the balance sheet. Unless otherwise stated, the historical operating and financial data of AmBev includes the operations of Bavaria through October 31, 2000.
 
Pepsi
 
In 1997, we acquired the Pepsi bottlers in southern and southeastern Brazil and the exclusive rights to produce, sell and distribute PepsiCo soft drink products in northeastern Brazil.  These rights were supeerceded by subsequent agreements with PepsiCo.  See Additional InformationMaterial Contracts.  Under Brazilian GAAP, the shareholders’ equity of these bottlers at the date of acquisition was zero, and since we paid a nominal amount for the business, no goodwill was recognized. Under U.S. GAAP, however, the acquisition gave rise to R$43.8 million of goodwill as of December 31, 1997 (which was being amortized over a 10-year period). In 1999, we obtained the exclusive rights to produce, sell and distribute PepsiCo soft drink products throughout Brazil. See “Information on the Company—AmBev Business Overview—Our Products and Brands”.
 
Effect of Direct Distribution on Results of Operations
 
Historically, both Brahma and Antarctica distributed their products through exclusive third-party distribution networks. In the second half of 1997, Brahma began to implement the direct distribution of its products. The positive impact generated in our results led us to the decision to shift part of our sales to a direct distribution system in many of our operations.
 
As the proportion of our net sales made through direct distribution rises, our results of operations are affected as follows:
 
·      
Net sales increases. Net sales made through direct distribution are greater than net sales made through third-parties. Under direct distribution, we receive a higher price for our products since we are selling directly to retail stores, capturing the gross margin previously retained by distributors.
 
·      
We incur transportation costs. When we sell our products directly, we incur freight costs in transporting our products between our plant and the point of sale, which are included in our cost of sales under U.S. GAAP and in our direct distribution expenses under Brazilian GAAP.
 
·      
Our sales, general and administrative expenses increase. Under the third-party distribution system, the salesperson is an employee of the distributor, while under direct distribution, the salesperson is our employee. As direct distribution grows, we incur additional direct distribution expenses from the hiring of additional employees which are offset by the increase in net sales.
 
Our working capital needs increase. Under our direct distribution system, we extend limited credit to some points of sale, based on market rates with terms ranging from two to twenty-one days. Accordingly, as we increase direct distribution to the points of sale, our receivables increase.
 
 
56

 
Foreign Currency Effects
 
We have significant amounts of U.S. dollar-denominated assets and liabilities and operating expenses denominated in or linked to U.S. dollars. However, a substantial majority of our revenues are generated in currencies which exchange rate to the U.S. dollar may present significant volatility.
 
Fluctuations in the exchange rate to the U.S. dollar of currencies in which our revenues are generated may cause the following impact on our results of operations:
 
·       
Increases in our cost of sales and operating expenses, negatively impacting our profit margins. Historically, we have been able to raise prices to partially offset cost and expenses increases. However, during periods of rapid devaluation or when the rate of devaluation significantly exceeds that of inflation, we may not be able to raise prices at a rate sufficient to offset our cost and expenses increases, or to recover such cost and expenses increases in future periods. For risk management purposes, we may decide to hedge the whole or part of our cost and expenses exposure in U.S. dollars in order to avoid short term volatility in our results.
 
·       
Volatility in our financial results, for the effects of fluctuations in exchange rates on our U.S. dollar transactions (i.e., cash, cash equivalents, short-term investments, investments abroad, loans and the unrealized gains and losses from foreign currency and interest rate swap contracts, among others) are recorded as financial income, financial expense and operating income (expense), net in our statements of operations.
 
We have policies designed to manage commodity and currency risks to protect our U.S. dollar denominated transactions and net assets from the significant devaluations of the currencies in which we operate. We may enter into commodity and cross-currency interest rate swap contracts to offset gains or losses generated by our U.S. dollar denominated transactions and loans.According to Brazilian accounting principles, liabilities must be recorded on an accrual basis rather than at market value, while assets must be recorded at the lower of their market value or accrual value.
 
Commodities Price Effects
 
·      
AmBev has a significant exposure to fluctuations in the price of aluminum, which increased by approximately 22% during 2004, increasing our cost of sales. For risk management purposes, we entered into hedging agreements during 2004, which had a positive impact on our results in 2004. Another significant exposure relates to fluctuations in the price of sugar, which decreased approximately 59% during 2004, increasing our cost of sales.
 
 
57

 
Taxes
 
Taxes on income
 
Income taxes in Brazil are comprised of federal income tax and social contribution (which is an additional federal income tax). The composite statutory rate applicable for the year ended on December 31, 2004, 2003 and 2002 was 34%. For the years of 2004, 2003 and 2002, our Brazilian GAAP effective tax rate was a charge of 30.5% in 2004, a charge of 23.2% in 2003 and a benefit of 23.7% in 2002.
 
The major reasons for the differences between the effective tax rates and the Brazilian composite statutory rates have been: (i) benefits arising from tax-deductible payments of interest on shareholders’ equity without an interest charge in pre-tax income; (ii) certain non-deductible expenses; (iii) earnings from offshore companies not subject to different foreign tax rates; (iv) valuation allowances against net operating losses and reversals; (v) non-taxable benefits arising from State value-added incentive programs; (vi) amortization of goodwill according Brazilian tax legislation; (vii) tax losses carry forward; and (viii) re-filings of tax returns following changes in interpretation of certain deductions
 
Under U.S. GAAP, we recorded a benefit of R$148.0 million in 2002 corresponding to 80% of the current value of tax loss carry forwards acquired at the time of the Pepsi transaction in 1997 which had been subject to certain restrictions through October 2002. Under Brazilian GAAP, which uses a different measurement criterion, this Pepsi tax asset was recorded as a credit to results in 2003.
 
Tax losses available for offset
 
We had recorded tax loss carryforward assets available for offset of R$1,090.9 million as of December 31, 2004. Income tax losses available for offset in Brazil do not expire; however, the annual offset is limited to 30% of pretax income.
 
New legislation was introduced in the third quarter of 2001 to subject offshore earnings to income tax in Brazil regardless of whether earnings have been remitted to Brazil and to restrict tax planning measures that have been available to companies in Brazil, including those we have made use of in the past. Although we do not believe that earnings that have been accumulated offshore will be taxed, the tax authorities may challenge our position on this matter and as a result our access to effective tax planning measures may be restricted in the future.
 
Year ended December 31, 2004 Compared with Year ended December 31, 2003
 
In 2004, AmBev revised how it reports its operating results to better reflect the expanding geographical scope of its business. Previously, our operating results were categorized into four primary business segments: Beer Brazil, CSD and NANC, Other Products and International Operations. In order to provide a more meaningful presentation of AmBev’s operations outside Brazil as that became a more significant portion of AmBev’s operations, our reports now reflect the following three business segments:

·  
Brazil, consisting of:
 
–  
Beer Brazil;
 
–  
CSD & NANC Brazil - carbonated soft drinks and non-alcoholic, non-carbonated segments; and
 
–  
Other products.
 
·  
Hispanic Latin America - HILA, consisting of:
 
–  
Quinsa – represents AmBev’s stake in Quinsa (54.8% as of December 31, 2004), which operates in Argentina, Bolivia, Chile, Paraguay and Uruguay; and
 
58

 
–  
HILA-ex – represents AmBev’s other operations in Latin America, where we distribute beer (Peru, Ecuador, Guatemala, El Salvador, Nicaragua and Venezuela) and soft drinks (Dominican Republic and Peru).
 
·  
North America, consisting of Labatt’s operations, including domestic sales in Canada and exports to the USA.
 
 AmBev’s operations in Brazil (“AmBev Brazil” or “Brazilian Operations”) reflect the Beer operations in Brazil, our carbonated soft drinks (“CSD”) and non-alcoholic, non-carbonated beverages (“NANC”) operations and other products. Our HILA Operations correspond to what we formerly referred to as our International Operations. Our North America business segment currently consists primarily of Labatt’s operations. As we had no sales outside of our Brazilian Operations and our former International Operations, now HILA Operations, until 2004, application of our new reporting methodology to prior periods does not result in any material changes to the reports previously made available for those periods.
 
The following table sets forth the consolidated financial highlights of AmBev for the years ended December 31, 2004 and 2003:
 
 
 
Consolidated Financial Highlights 
     
2004
   
2003
   
% Change
 
Brazilian GAAP
 
(R$ in millions, except volume amounts, percentages and per share amounts)
                     
Sales volume—000 hectoliters(1)
   
98,272
   
84,310
   
16.6
%
Net sales
   
12,006.8
   
8,683.8
   
38.3
 
Net revenue per hectoliter—R$/hl
   
122.2
   
103.0
   
18.6
 
Cost of sales
   
(4,780.5
)
 
(4,044.2
)
 
18.2
 
Gross profit
   
7,226.3
   
4,639.6
   
55.8
 
Gross margin (%)
   
60.2
%
 
53.4
%
     
Selling, general and administrative expenses
                   
Selling and marketing expenses
   
(1,582.8
)
 
(847.1
)
 
86.8
 
Direct distribution expenses
   
(868.9
)
 
(648.6
)
 
34.0
 
General and administrative expenses,
including directors’ fees
   
(617.9
)
 
(417.9
)
 
47.9
 
Depreciation and amortization(2)
   
(541.5
)
 
(420.0
)
 
28.9
 
Total selling, general and administrative expense
   
(3,611.1
)
 
(2,333.5
)
 
54.8
 
Provisions for contingencies
   
(260.2
)
 
(187.9
)
 
38.5
 
Other operating income (expenses), net
   
(420.9
)
 
(240.1
)
 
75.3
 
Equity in results of subsidiaries
   
5.6
 
 
(6.2
)
 
(9.7
)
Net financial income (expenses)
   
(776.4
)
 
93.1
   
 
Operating income(4)
   
2,163.3
   
1,964.9
   
10.1
 
Operating margin (%)
   
18.0
%
 
22.6
%
     
Net income
   
1,161.5
   
1,411.6
   
(17.7
)
Net margin
   
9.7
%
 
16.3
%
     
Earnings per share - R$/000 shares(3)
   
21.26
   
37.23
   
(42.9
)
 
___________________________
Amounts may not add due to rounding.
(1)
Total beverage sales volume combines AmBev’s own beverage volume with its ownership percentage share of volume in Quinsa.
(2)
Does not include depreciation recorded on production assets which is recorded within cost of sales, nor amortization of goodwill which is within Other operating income, net.
(3)
Calculated based on year-end number of shares, excluding treasury shares.
(4)
Under Brazilian GAAP, operating income includes net financial expense.
 
 Margin Analysis
 
The following table sets forth certain items in our statement of operations expressed as percentages of net sales for the years ended December 31, 2004 and 2003:
 
59

 
 
 
 
Year ended December 31, 
         
2003
 
 
   
(%)
   
(%)
 
               
Net sales
   
100.0
   
100.0
 
Cost of sales
   
(39.8
)
 
(46.6
)
Gross profit
   
60.2
   
53.4
 
Selling and marketing expenses
   
(13.2
)
 
(9.8
)
Direct distribution expenses
   
(7.2
)
 
(7.5
)
General and administrative expenses, including directors’ fees
   
(5.1
)
 
(4.8
)
Depreciation and amortization
   
(4.5
)
 
(4.8
)
Provision for contingencies
   
(2.2
)
 
(2.2
)
Other operating income (expenses), net
   
(3.5
)
 
(2.8
)
Net financial income (expenses)
   
(6.5
)
 
1.1
 
               
Operating income (expenses)(1)
   
18.0
   
22.6
 
               
________________________
(1) Under Brazilian GAAP, operating income includes net financial expense.

Financial Highlights by Business Segment
 
The following table sets forth certain financial highlights by business segment for the years ended December 31, 2004 and 2003:
 
   
Year ended December 31,
   
2003
 
 
(R$ in millions) 
   
Brazil 
   
HILA
 
 
North America(1)
 
 
Brazil
   
HILA
 
 
North America
 
                                       
Net sales
   
8,525.9
   
1,922.1
   
1,558.8
   
7,637.7
   
1,046.1
   
N/A
 
Cost of sales
   
(3,368.6
)
 
(909.5
)
 
(502.4
)
 
(3,509.4
)
 
(534.7
)
 
N/A
 
Gross profit
   
5,157.3
   
1,012.5
   
1,056.4
   
4,128.3
   
511.3
   
N/A
 
Selling, general and administrative expenses
   
(2,416.8
)
 
(638.4
)
 
(556.1
)
 
(1,957.5
)
 
(376.0
)
 
N/A
 
____________
(1) North America’s results reflect the consolidation of Labatt’s operating results from August 27, 2004 through December 31, 2004.

Net Sales
 
Net sales increased by 38.3% for the year ended December 31, 2004 to R$12,006.8 million from R$8,683.8 million in the same period in 2003. This increase was a result of an organic growth of 12.0% and a contribution of R$2,278.7 million of new investments made during 2004.
 
60

 
 
 
Sales Volumes
Year ended December 31, 
   
2003
2002
 
 
(Thousands of hectoliters, except percentages) 
Brazil
   
76,884.9
   
69.2
%
 
74,058.4
   
78.3
%
 
77,650.4
   
98.3
%
Beer Brazil
   
57,776.8
   
52.0
%
 
55,260.2
   
58.4
%
 
58,009.6
   
73.5
%
CSD & NANC
   
19,108.2
   
17.2
%
 
18,798.3
   
19.9
%
 
19,640.8
   
24.9
%
Other Products
   
   
   
   
   
   
 
HILA
   
28,333.2
   
25.5
%
 
20.301.3
   
21.5
%
 
1,327.1
   
1.7
%
Quinsa(1)
   
22,145.9
   
19.9
%
 
18,514.6
   
19.6
%
 
   
 
HILA-ex
   
6,187.2
   
5.6
%
 
1,786.7
   
1.9
%
 
1,327.1
   
1.7
%
North America(2)
   
5,841.6
   
5.3
%
 
   
   
   
 
AmBev Consolidated
   
111,059.7
   
100.0
%
 
94,359.7
   
100.0
%
 
78,977.5
   
100.0
%
_________________________
(1)
Represents AmBev’s share of Quinsa’s sale volumes.
(2)
Consists of the results of Labatt’s operations from August 27, 2004 through December 31, 2004.
 
Source: AmBev
 
Brazilian Operations
 
Net sales from our Brazilian Operations increased by 11.6% for the year ended December 31, 2004 to R$8,525.9 million from R$7,637.7 million in the same period in 2003, primarily as a result of growth in beer and CSD & NANC sales.
 
      Beer Brazil. Net sales of beer in Brazil increased by 13.0% for the year ended December 31, 2004 to R$6,907.4 million from R$6,114.6 million in the same period in 2003. This was due to a 4.6% increase in volumes sold as a result of a 1.8% increase in the Brazilian beer market, according to ACNielsen, and a higher market share in the period (66.2% in the year ended December 31, 2004 compared to 67.2 % in the same period in 2003). Net sales per hectoliter increased by 8.0% to R$119.6/hl in 2004 from R$110.7/hl in 2003, mainly as a result of punctual price adjustments implemented during 2004 and greater contribution in the sales mix from our direct sale operation (40.7% in 2004 compared with 32.4% in 2003).
 
CSD & NANC. Net sales increased by 9.8% for the year ended December 31, 2004 to R$1,462.8 million from R$1,332.1 million in the same period in 2003 mainly as a result of a 4.4% increase in CSD, net sales for the year ended December 31, 2004 to R$1,356.2 million from R$1,205.1 million in the same period in 2003 and an 8% increase in net sales per hectoliter for soft drinks for the year ended December 31, 2004 compared with the same period in 2003, mainly as a result of price repositioning implemented during 2004 and a focus on our greater profitability packages and brands.
 
Other Products. Net sales decreased by 18.4% for the year ended December 31, 2004 to R$155.8 million from R$191.0 million in the same period in 2003.
 
HILA Operations
 
Net sales increased by 83.7% for the year ended December 31, 2004 to R$1,922.1 million from R$1,046.1 million in the same period in 2003. Both Quinsa’s performance and our HILA-ex operations contributed to this result. The growth in beer and soft drinks sales volume, of 18.3% and 23.1% respectively, also contributed to this increase. In addition, the 9.7% increase in revenues per hectoliter in dollar terms and the increase of AmBev’s stake in Quinsa’s capital, to 54.8% in the year ended December 31, 2004 from 49.7% for the same period in 2003, both contributed to this increase. Our stake in Quinsa contributed R$1,153.0 million, a 49.0% increase.
 
On a per hectoliter basis, cost of sales for our HILA Operations decreased by 1.8% for the year ended December 31, 2004 to R$51.2/hl from R$52.2/hl in the same period in 2003
 
61

 
 Our operation in the Hila-ex region, represented by operations in Ecuador, Guatemala, Nicaragua, Peru, the Dominican Republic and Venezuela, showed a 182.4% increase in revenues for the year ended December 31, 2004 when compared to the same period in 2003 to R$769.1 million. The main elements contributing to this increase were the following: (i) the 43.9% growth in Venezuela volumes; (ii) the first full year of operations in Ecuador, Guatemala and Peru; (iii) our entrance into the Nicaragua market; (iv) the launching of Brahma in Ecuador, with a market share estimated at 17.9% in December 2004; and (v) our investment in Embodom in February 2004, the anchoring bottling company of Pepsi Cola in the Caribbean and the leading player in the Dominican Republic’s soft drinks market with a 59.7% market share.
 
North America
 
Net sales in North America for the year ended December 31, 2004 reflect four months of consolidated results of Labatt and totaled R$1,558.8 million. These sales were primarily a result of sales of 3.02 million hectoliters of beer in the Canadian market, with revenues per hectoliter of C$208.1/hl, and an increase in Budweiser market share, the top brand in Canada, to 12.3% in December 2004. Labatt also exported 0.60 million hectoliters of beer to the United States over the four month period, with revenues per hectoliter of C$61.7/hl. 
 
Cost of Sales
 
Total cost of sales increased by 18.2% for the year ended December 31, 2004 to R$4,780.5 million from R$4,044.2 million in the same period in 2003. During most of 2004 and 2003, we had currency hedge agreements in place to manage our exposure to variable U.S. dollar-linked costs, such as costs associated with aluminum cans, malt, hops sugar and PET resin.  
 
As a percentage of our net sales, total cost of sales decreased to 39.8% in 2004 from 46.6% in 2003.
 
Brazilian Operations
 
Total cost of sales for our Brazilian operations decreased by 4.0% for the year ended December 31, 2004 to R$3,368.6 million from R$3,509.4 million in the same period in 2003.
 
On a per hectoliter basis, our Brazilian operations’ cost of sales decreased by 7.5% for the year ended December 31, 2004 to R$43.8/hl from R$47.4/hl in the same period in 2003.
 
Beer Brazil. Cost of sales for our Brazilian Beer operations decreased by 1.5% for the year ended December 31, 2004 to R$2,467.0 million from R$2,503.6 million in the same period in 2003. On a per hectoliter basis, cost of sales for our Brazilian Beer operations decreased by 5.8% for the year ended December 31, 2004 R$42.7/hl from R$45.3/hl in the same period in 2003. This decrease was primarily a result of the following: (i) a 12.4% reduction in the effective exchange rate used by AmBev in the purchase of inputs that are sensitive to the U.S. dollar fluctuation (the average exchange rate in 2004 was R$2.94/U.S.$, compared to R$3.35/U.S.$ in 2003), (ii) a greater dilution of fixed costs based on the 4.6% increase in sales volume; and (iii) a reduction in the prices of raw materials for the preparation of beer. These factors offset the increase in packaging costs caused by high aluminum prices during 2004.
 
CSD & NANC. Cost of sales for our Brazilian CSD & NANC operations decreased by 7.5% for the year ended December 31, 2004 to R$820.5 million from R$887.3 million in the same period in 2003. On a per hectoliter basis, cost of sales decreased 9.0% for the year ended December 31, 2004 to R$42.9/hl from R$47.2/hl in the same period in 2003. This decrease was primarily as a result of a significant reduction in the R$/U.S.$ exchange rate, the lower cost of sugar during the first half of 2004 and the timely hedging for our sugar exposure position in the second half of the year.
 
Other Operations. The cost of sale of byproducts in Brazil decreased by 31.6% for the year ended December 31, 2004 to R$81.1 million from R$118.6 million for the same period in 2003.
 
HILA Operations
 
Cost of sales for our HILA Operations increased by 70.1% for the year ended December 31, 2004 to R$909.5 million from R$534.7 million in the same period in 2003. On a per hectoliter basis, cost of sales for our
 
62

 
HILA Operations decreased by 1.8% for the year ended December 31, 2004 to R$51.2/hl from R$52.2/hl in the same period in 2003.
 
The consolidation of Quinsa’s cost of sales was R$510.3 million in the year ended December 31, 2004, representing an increase of 31.8% over the same period in 2003, due to the 14% increase, in U.S. dollars terms, of Quinsa’s cost of sales which was partially offset by the cost of sales per hectoliter that dropped 4.0%, reaching U.S.$15.3/hl. Cost of sales also increased due to the increase in our economic interest in Quinsa.
 
The cost of sales in our HILA-ex operations for the year ended December 31, 2004 rose 170.7%, to R$399.3 million due primarily to the increase in our investments and our expansion of our operations in the region. From September 2003 through December 2004, we started up operations in Ecuador, Guatemala, Nicaragua, Peru and the Dominican Republic and had a 43.9% volume increase in our operation in Venezuela.
 
North America
 
Our cost of sales in North America was R$502.4 million for the year ended December 31, 2004.
 
Gross Profit
 
Gross profit increased by 55.8% for the year ended December 31, 2004 to R$7,226.3 million from R$4,639.6 million in the same period in 2003. Gross margin as a percentage of sales increased to 60.2% in 2004 from 53.4% in 2003. This positive result was due to organic growth of 37.9% and a contribution of R$1,423.4 million of new investments made during 2004. The table below sets forth the contribution of each business unit to AmBev’s consolidated gross profit.
 

 
Gross Profit 
   
2004
2003
 
 
(R$ in millions, except percentages) 
   
Amount
  %     
Margin
   
Amount
 
 
% 
   
Margin
 
Brazilian Operations
   
5,157.3
   
71.4
%
 
60.5
%
 
4,128.3
   
89.0
%
 
54.1
%
Beer Brazil
   
4,440.3
   
61.4
%
 
64.3
%
 
3,611.0
   
77.8
%
 
59.1
%
CSD & NANC Brazil
   
642.2
   
8.9
%
 
43.9
%
 
444.9
   
9.6
%
 
33.4
%
Other Products
   
74.7
   
1.0
%
 
48.0
%
 
72.3
   
1.6
%
 
37.9
%
HILA Operations
   
1,012.5
   
14.0
%
 
52.7
%
 
511.3
   
11.0
%
 
48.9
%
Quinsa(1)
   
642.7
   
8.9
%
 
55.7
%
 
386.4
   
8.3
%
 
49.9
%
Hila-ex
   
369.9
   
5.1
%
 
48.1
%
 
124.9
   
2.7
%
 
45.9
%
North America(2)
   
1,056.4
   
14.6
%
 
67.8
%
 
   
   
 
            Total
   
7,226.3
   
100.0
%
 
60.2
%
 
4,639.6
   
100.0
%
 
53.4
%
____________
(1)
Calculated based on our proportional share of the results of operations of Quinsa.
(2)
 
North America’s results reflect the consolidation of Labatt’s operating results from August 27, 2004 through December 31, 2004.
 
 
Selling and Marketing Expenses
 
Selling and marketing expenses increased by 86.9% for the year ended December 31, 2004 to R$1,582.8 from R$847.1 million for the same period in 2003.
 
Brazilian Operations
 
Selling and marketing expenses for our Brazilian operations increased 32.8% for the year ended December 31, 2004 to R$833.7 million from R$627.9 million in 2003. Selling and marketing expenses for the Brazilian beer operation reached R$736.5 million for the year ended December 31, 2004, an increase of 37.9% from the same period in 2003. The increase in expenses was a result of (i) higher expenditures related to advertising and promotion and (ii) the enlargement of our trade marketing programs. Brazilian CSD & NANC selling and marketing expenses totaled R$97.2 million for the year ended December 31, 2004, an increase of 3.4% when compared to the same period in 2003, mainly due to (i) the development of the Guaraná Antarctica brand, the flagship of our CSD & NANC portfolio, and (ii) the implementation of new trade marketing programs.
 
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HILA Operations
 
Selling and marketing expenses for HILA Operations totaled R$337.9 million for the year ended December 31, 2004, increasing 54.2% when compared to the same period in 2003. Our consolidated selling and marketing expenses in Quinsa totaled R$210.8 million for the year ended December 31, 2004, increasing 31.9% when compared to the same period in 2003, due mainly to a 15.1% (in US dollars terms) increase in the sales and marketing expenses of Quinsa and the increase of our stake in Quinsa. Selling and marketing expenses for our HILA-ex operations amounted to R$127.2 million for the year ended December 31, 2004, increasing 114.5% when compared to the same period in 2003. The main causes of this increase were (i) the consolidation of new operations started by AmBev during its expansion process and (ii) investments made to promote the launching of Brahma in Ecuador.
  
North America
 
Selling and marketing expenses in North America for the year ended December 31, 2004 totaled R$411.2 million.
 
Direct Distribution Expenses
 
Direct distribution expenses include product delivery charges and delivery personnel required to distribute our products. Direct distribution expenses increased by 34% for the year ended December 31, 2004 to R$869.0 million from R$648.6 million in the same period in 2003.
 
Brazilian Operations
 
Direct distribution expenses in Brazilian Operations totaled R$753.2 million for the year ended December 31, 2004, increasing 24.5% from R$605.2 million for the year ended December 31, 2003. This increase in expenses is explained primarily by an increase of 23.0% in the volume sold by direct distribution in our Brazilian Operations, representing 43.7% of the total sales volume in 2004 compared with 36.9% in 2003, reflecting our strategy to increase the percentage of volumes of our Brazilian Operations sold through our direct distribution network. On a per hectoliter basis, our Brazilian Operations’ direct distribution expenses increased 1.1% for the year ended December 31, 2004 to R$22.4/hl from R$22.2/hl for the same period in 2003.
 
HILA Operations
 
Direct distribution expenses in our HILA Operations totaled R$88.3 million, increasing by 103.4%. These expenses refer solely to our HILA-ex operations as direct distribution expenses in Quinsa are recorded as sales and marketing expenses. This increase is a result of (i) an increase of 48.4% in direct distribution volumes in Venezuela and (ii) the implementation of direct distribution in Peru.
 
North America
 
Direct distribution expenses in North America totaled R$27.5 million.
 
General and Administrative Expenses
 
General and administrative expenses increased by 47.9% for the year ended December 31, 2004 to R$617.9 million from R$417.9 million in the same period in 2003, primarily as a result of higher fees paid to our executive officers as part of our variable remuneration plan and the impact of (i) our operations in North America and (ii) the increase of our HILA-ex operations.
 
Brazilian Operations
 
General and administrative expenses for our Brazilian Operations were R$389.6 million in 2004, a 10.8% increase from R$351.6 million in 2003 due mainly to the higher fees paid to our board of executive officers as part of our variable remuneration system.
 
64

 
HILA Operations
 
The general and administrative expenses for our HILA Operations were R$130.1 million for the year ended December 31, 2004, increasing 96.4% from R$66.3 million in the same period in 2003. This was as a result of (i) the consolidated administrative expenses in Quinsa of R$50.0 million and (ii) a 188.0% increase in our HILA-ex expenses, totaling R$80.2 million, due to the consolidation of new operations.
 
North America
 
In North America, Labatt’s administrative expenses amounted to R$98.2 million.
 
Depreciation and Amortization Expenses
 
Depreciation and amortization expenses increased by 28.9% for the year ended December 31, 2004 to R$541.5 million from R$420.0 million in the same period in 2003. Brazilian Operations’ depreciation and amortization increased by 18.1% for the year ended December 31, 2004 to R$440.2 million from R$372.9 million in 2003. This increase was a result of the continuation of our program to install coolers at points of sale. HILA Operations’ depreciation and amortization increased by 74.1% for the year ended December 31, 2004 to R$82.1 million from R$47.1 million in 2003. Depreciation and amortization in North America amounted to R$83.9 million.
 
Provisions for contingencies
 
Net provisions for contingencies charged to the statement of operations amounted to R$260.2 million in 2004, a 38.4% increase from R$187.9 million for the year ended December 31, 2003. Provisions for contingencies with respect to Brazilian Operations were R$258.7 million in 2004, mainly comprised of: (i) R$141.6 million for labor provisions; (ii) R$74.5 million for ICMS taxes credit with respect to purchases of property, plant and equipment prior to 1996, which are under dispute; and (iii) R$21.2 million related to the termination of certain third-party distribution agreements.
 
Provisions for contingencies for HILA operations were R$1.5 million in 2004, down R$45.3 million from R$43.8 million in 2003.
 
Other operating income (expense), net
 
Other (net) operating expenses for the year ended December 31, 2004 were R$420.9 million, 75.3% higher than expenses of R$240.1 million for the year ended December 31, 2003. Brazilian Operations contributed with income of R$115.3 million compared to R$230.7 million in expenses in 2003, related mostly to: (i) income of R$193.3 million from tax incentives; (ii) income of R$163.5 million derived from the impact of exchange rate variation over AmBev’s investments outside of Brazil. The impact of the exchange rate variation on investment in Labatt was R$259.4 million while negative impacts arising from the exchange rate variation in other investments totaled R$163.5 million; (iii) a loss of R$210.7 million related to the amortization of goodwill; and (iv) a loss of R$67.7 million stemming from the levy of PIS/COFINS on other operating income.
 
Other operating expenses for HILA Operations were R$88.2 million for the year ended December 31, 2004 compared to R$9.4 million of expenses for the same period in 2003.
 
North America had expenses of R$448.2 million for the year ended December 31, 2004, mainly explained by the goodwill amortization incurred through the incorporation of Labatt into AmBev.
 
Net Financial Income (Expenses)
 
Our financial income consists of realized and unrealized gains from financial instruments, foreign exchange gains (losses) on investments, financial income on cash equivalents and others. Our financial expenses consist of foreign exchange gains (losses) on loans, realized and unrealized losses from financial instruments, interests and charges on loans, taxes on financial transactions, interest on contingencies and others.
 
65

 
We enter into hedging transactions to address AmBev’s Brazilian foreign currency debt exposure, which involve cash investments in U.S. dollar-linked assets, as well as the use of swaps and derivatives. As a result of Brazilian accounting requirements, volatility in the real/U.S. dollar exchange rate and interest rates can cause significant variations in financial income and expenses.
 
Financial income for the year ended December 31, 2004 was R$339.2 compared to financial income of R$601.8 million in the same period in 2003, primarily due to the change in the financial income derived from our Brazilian Operations, which posted a loss of R$654.4 million in 2004 compared to a gain of R$107.7 million in 2003. This change is a result of the requirement of Brazilian GAAP that financial assets related to derivative instruments used in hedging operations should be accounted for by the lesser of the book value and the market value. A significant drop in the exchange coupon and in the country risk between the fourth quarter of 2002 and the second quarter of 2003 led AmBev to register significant unrealized gains during these periods. Therefore, the financial income achieved in 2003 principally reflected the volatility generated in the Brazilian capital markets due to presidential elections in 2002.
 
Financial expenses for the year ended December 31, 2004 were R$1,115.6 million compared to R$508.7 million in the same period in 2003. This difference can be explained by a higher debt balance and the accounting impact of hedging transactions in 2004. The financial expenses of the HILA Operations were R$84.5 million for the year ended December 31, 2004 compared to R$14.7 million in 2003. North America had net financial expenses of R$37.4 million for the year ended December 31, 2004.
 
Operating income
 
Operating income increased by 10.1% for the year ended December 31, 2004 to R$2,163.3 million from R$1,964.9 million in the same period in 2003.
 
Non-Operating income (expense), net
 
Non-operating expenses increased by 231.6% for the year ended December 31, 2004 to R$333.9 million from expenses of R$100.7 million in the same period in 2003. Brazilian Operations’ non-operating expenses amounted to R$129.6 million for the year ended December 31, 2004, mainly as a result of a R$37.0 million expense related to losses on the sale of fixed assets and a R$86.7 million expense related to Quinsa’s share buyback programs, which, despite increasing our stake in Quinsa, had a negative effect on Quinsa’s shareholders equity because of the difference between the market value and book value of Quinsa’s shares. HILA Operations had non-operating expenses of R$5.5 million. North America had non-operating expenses of R$198.7 million, primarily resulting from severance expenses of 240 former Labatt employees, related to the restructuring of Labatt’s administrative activities.
 
Income tax benefit (expense)
 
Our consolidated income tax and social contribution for the year ended December 31, 2004 was a charge of R$511.8 million, up 20.0% from R$426.1 million in 2003. At the nominal tax rate of 34%, income tax for the year ended December 31, 2004 would have amounted to R$570.2 million. Our effective income tax rate in the year ended December 31, 2004 was positively affected by the benefit from tax deductible distribution of interest attributed to shareholder’s equity (R$270.0 million) and non-taxable equity gains attributable to subsidiaries (R$65.7 million). The effect of R$155.8 million of income taxes and social contibution on results of Labatt negatively affected our effective tax rate.
 
Profit sharing and contributions
 
Provision for employee and management profit sharing increased to R$152.4 million for the year ended December 31, 2004 from R$23.6 million in the same period in 2003. In 2003, as AmBev’s corporate goals were not met, amounts under our profit sharing plan were paid only to employees from the top performing industrial, sales and distribution units and none were paid to administrative employees. In 2004, as AmBev’s corporate goals were met, our administrative employees were entitled to bonuses under our profit sharing plan. See “Directors, Senior Management and Employees—Compensation—Profit Sharing Plan”.
 
66

 
Minority interest
 
Minority shareholders in our subsidiaries shared in gains of R$3.7 million for the year ended December 31, 2004 compared to gains of R$2.9 million in 2003.
 
Net Income
 
Net income decreased by 17.7% for the year ended December 31, 2004 to R$1,161.5 million from R$1,411.6 million in the same period in 2003.
  
Year ended December 31, 2003 Compared with Year ended December 31, 2002
 
The following table sets forth the consolidated financial highlights of AmBev for the years ended December 31, 2003 and 2002:
 
 
 Consolidated Financial Highlights
     
2003
   
2002
   
% Change
 
Brazilian GAAP
 (R$ in millions, except volume amounts, percentages
and per share amounts)
                     
Sales volume—000 hectoliters(1)
   
84,310
   
81,590
   
3.3
 
Net sales
   
8,683.8
   
7,325.3
   
18.5
 
Net revenue per hectoliter—R$/hl
   
103.0
   
89.8
   
14.7
 
Cost of sales
   
(4,044.2
)
 
(3,341.7
)
 
21.0
 
Gross profit
   
4,639.6
   
3,983.6
   
16.5
 
Gross margin (%)
   
53.4
%
 
54.4
%
     
Selling, general and administrative expenses
                   
Selling and marketing expenses
   
(847.1
)
 
(687.2
)
 
23.3
 
Direct distribution expenses
   
(648.6
)
 
(537.4
)
 
20.7
 
General and administrative expenses, including directors’ fees
   
(417.9
)
 
(373.5
)
 
11.9
 
Depreciation and amortization(2)
   
(420.0
)
 
(334.6
)
 
25.5
 
 Total selling, general and administrative expenses
   
(2,333.5
)
 
(1,932.7
)
 
20.7
 
Provisions for contingencies
   
(187.9
)
 
(123.7
)
 
51.9
 
Other operating income (expense), net
   
(240.1
)
 
199.4
   
-
 
Equity in results of affiliates
   
(6.2
)
 
-
   
-
 
Net financial income (expenses)
   
93.1
   
(747.1
)
 
-
 
Operating income(4)
   
1,964.9
   
1,379.5
   
42.4
 
Operating margin (%)
   
22.6
%
 
18.8
%
     
Net income
   
1,411.6
   
1,510.3
   
(6.5
)
Net margin
   
16.3
%
 
20.6
%
     
Earnings per share - R$/000 shares(3)
   
37.23
   
39.48
   
(5.7
)
 
________________________________
 
Amounts may not add due to rounding.
(1) Total beverage sales volume combines AmBev’s own beverage volume with its ownership percentage share of volume in Quinsa.
(2) Does not include depreciation recorded on production assets which is recorded within Cost of sales, nor amortization of goodwill which is within Other operating income, net.
(3) Calculated based on year end number of shares, excluding treasury shares.
(4) Under Brazilian GAAP, operating income includes net financial expense.
 
 
67


 
Margin Analysis
 
The following table sets forth certain items in our statement of operations expressed as percentages of net sales for the years ended December 31, 2003 and 2002:
 
 
Year ended December 31,
         
2002
 
 
    (%)     
(%)
 
               
Net sales
   
100.0
   
100.0
 
Cost of sales
   
(46.6
)
 
(45.6
)
Gross profit
   
53.4
   
54.4
 
Selling and marketing expenses
   
(9.8
)
 
(9.4
)
Direct distribution expenses
   
(7.5
)
 
(7.3
)
General and administrative expenses, including directors’ fees
   
(4.8
)
 
(5.1
)
Depreciation and amortization
   
(4.8
)
 
(4.6
)
Provision for contingencies
   
(2.2
)
 
(1.7
)
Other operating income (expense), net
   
(2.8
)
 
2.7
 
Net financial income (expenses)
   
1.1
   
(10.2
)
               
Operating income(1)
   
22.6
   
18.8
 
______________________
(1) Under Brazilian GAAP, operating income includes net financial expense

Financial Highlights by Business Segment
 
The following table sets forth certain financial highlights by business segment for the years ended December 31, 2003 and 2002:
 
 
Year ended December 31, 
   
2002
   
Brazilian Operations 
   
HILA Operations
   
Brazilian
Operations
   
HILA
Operations
 
                           
Net sales
   
7,637.7
   
1,046.1
   
6,929.0
   
396.3
 
Cost of sales
   
(3,509.4
)
 
(534.7
)
 
(3,127.6
)
 
(214.1
)
Gross profit
   
4,128.3
   
511.3
   
3,801.4
   
182.2
 
Selling, general and administrative
       expenses
   
(1,957.5
)
 
(376.0
)
 
(1,767.5
)
 
(165.2
)

Net Sales
 
Net sales increased by 18.5% for the year ended December 31, 2003 to R$8,683.8 million from R$7,325.3 million in the same period in 2002. This increase was not only due to growth in our Brazilian Operations, but also growth in our HILA Operations, mainly as a result of the acquisition of our stake in Quinsa and expansion into new international markets.
 
Brazilian Operations
 
Net sales from our Brazilian Operations increased by 10.2% for the year ended December 31, 2003 to R$7,637.7 million from R$6,929.0 million in the same period in 2002, primarily as a result of our revenue management initiatives, better execution at the point of sale, an increase in volumes sold directly and certain price realignments implemented during 2003.
 
Beer Brazil. Net sales of beer in Brazil increased by 10.2% for the year ended December 31, 2003 to R$6,114.6 million from R$5,546.4 million in the same period in 2002, despite a 4.7% decrease in volumes sold as a
 
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result of a 2.1% decline in the Brazilian beer market, according to ACNielsen, and a lower weighted average market share in the period (67.3% in the year ended December 31, 2003 compared to 68.4% in the same period in 2002). Net sales per hectoliter increased by 15.7% to R$110.7 in 2003 from R$95.6 in 2002, mainly as a result of our revenue management initiatives, better brand mix, higher volumes sold through our direct distribution network and a price realignment implemented in June/July 2003. During the year, consumer prices for our main brands remained in line with inflation. Other reasons for the growth in net sales per hectoliter of Brazilian beer include: (i) the launch of new super premium brands such as Bohemia Dark, Bohemia Weiss and Brahma Light; (ii) the revitalization of our super premium brand Original; and (iii) further initiatives in sales force training to help standardize and improve point of sale execution.
 
CSD & NANC. Net sales increased by 8.4% for the year ended December 31, 2003 to R$1,332.1 million from R$1,228.9 million in the same period in 2002. In the CSD division, net sales increased by 9.9% for the year ended December 31, 2003 to R$1,205.1 million from R$1,096.3 million in the same period in 2002, primarily as a result of 13.1% higher net revenues per hectoliter combined with a 2.8% decrease in volumes sold. Although total soft drink volumes sold decreased by 2.8%, our core portfolio Guaraná Antarctica and Pepsi volumes sold increased by 5.3% in 2003 reflecting our strategy to focus on higher margin brands, as well as the introduction of Pepsi Twist in a two liter PET bottle package. Net sales per hectoliter for soft drinks increased by 13.1% for the year ended December 31, 2003 to R$68.1 in 2003 from R$60.2 in the same period in 2002, mainly as a result of better brand mix (the percentage of our core portfolio in total volumes sold increased to 84.7% from 78.2%), higher volumes sold through our direct distribution network and price initiatives implemented during 2003. A higher percentage of PET bottles in the packaging mix contributed to partially offset the gains in net sales per hectoliter described above.
 
In the NANC division, net sales decreased by 4.2% for the year ended December 31, 2003 to R$127.1 million from R$132.7 million in the same period in 2002. This 4.2% decrease in net sales reflects AmBev’s strategy to focus on higher margin products, mainly Gatorade, resulting in a 23.2% decrease in volumes sold, but a 24.7% increase in net sales per hectoliter.
 
Other Products. Net sales increased by 24.2% for the year ended December 31, 2003 to R$190.9 million from R$153.7 million in the same period in 2002, primarily as a result of higher malt and by-products volumes sold to third parties.
 
HILA Operations
 
Net sales increased by 164.0% for the year ended December 31, 2003, to R$1,046.1 million from R$396.3 million in the same period in 2002, primarily as a consequence of an adequate combination of strategic alliances, joint ventures, greenfield projects and acquisitions, which allowed us to expand our operations into most of South America and to initiate operations in the Central America region. On January 31, 2003 we completed the acquisition of our interest in Quinsa, initially obtaining an economic interest of 40.475%. During the course of 2003, we acquired an additional 12.0 million Quinsa Class B shares through open market purchases, increasing our economic interest in Quinsa to over 50% by the end of the year. In 2003, Quinsa contributed net sales of R$773.7 million, or 74.0% of our HILA Operations’ net sales. In September 2003, we initiated our operations in the Guatemalan beer market through our joint venture with the local Pepsi bottler, CabCorp. Our Guatemalan operations contributed a net sales of R$22.0 million in 2003. In November 2003, we acquired various assets from Embotelladora Rivera in Peru, including PepsiCo’s franchise agreement for Northern Peru and Lima, as well as two soft drink plants in Peru and some sales and distribution assets in Lima. Our Peruvian assets contributed net sales of R$23.6 million in 2003. Finally, in December 2003, we acquired Cerveceria SurAmericana, the second largest brewer in Ecuador.
 
Cost of Sales
 
Total cost of sales increased by 21.0% for the year ended December 31, 2003 to R$4,044.2 million from R$3,341.7 million in the same period in 2002. During most of 2003 and 2002, we had currency hedge agreements in place to manage our exposure to variable U.S. dollar-linked costs, such as costs associated with aluminum cans, malt, hops sugar and PET resin. As opposed to 2002, however, the U.S. dollar exchange rate implicit in our currency hedge agreements was higher than the exchange rate prevailing in the market (we refer to this difference as the “currency hedge effect”), generating a loss of R$99.0 million in 2003 (which had the effect of increasing our costs
 
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of sales by R$99.0 million) as compared to a gain of R$345.7 million in 2002 (which had the effect of reducing our costs of sales by R$345.7 million).
 
As a percentage of our net sales, total cost of sales increased to 46.6% in 2003 from 45.6% in 2002.
 
Brazilian Operations
 
Total cost of sales for our Brazilian Operations increased by 12.2% for the year ended December 31, 2003 to R$3,509.4 million from R$3,127.6 million in the same period in 2002. As noted above, our cost of sales was negatively affected by the U.S. dollar exchange rate implicit in our hedging obligations in 2003 compared to the implicit exchange rate in 2002.
 
On a per hectoliter basis, our Brazilian Operations’ cost of sales increased by 17.6% for the year ended December 31, 2003 to R$47.4/hl from R$40.3/hl in the same period in 2002. The negative impact of the implicit exchange rate for our cost of sales in 2003 was partially offset by our efforts to reduce our cost of sales by: (i) reducing prices paid for raw material, packaging and utilities through negotiation, development of new domestic and international suppliers and tolling arrangements; (ii) increasing conversion yields through several multifunctional initiatives and projects; (iii) packaging engineering; (iv) process and packaging efficiency through improved plant floor execution; and (v) reducing fixed costs through centralization.
 
Beer Brazil. Cost of sales for our Brazilian Beer Operations increased by 11.9% for the year ended December 31, 2003 to R$2,503.6 million from R$2,237.1 million in the same period in 2002, primarily as a result of the higher U.S. dollar exchange rate implicit in our cost of sales in 2003 compared to 2002.
 
On a per hectoliter basis, cost of sales for our Brazilian Beer Operations increased by 17.5% for the year ended December 31, 2003 to R$45.3/hl from R$38.6/hl in the same period in 2002. The primary negative factor which affected costs of sales in 2003 was a higher percentage of imported barley in our malt mix, mainly as a result of the poor barley harvest in South America, as well as lower volumes, which increased the fixed cost per hectoliter.
 
CSD & NANC. Cost of sales for our Brazilian CSD & NANC Operations increased by 9.7% for the year ended December 31, 2003 to R$887.3 million from R$809.0 million in the same period in 2002. On a per hectoliter basis, cost of sales increased 14.6% for the year ended December 31, 2003 to R$47.2/hl from R$41.2/hl in the same period in 2002, primarily as a result of the higher U.S. dollar exchange rate implicit in our costs in 2003 compared to 2002, which more than offset the gains generated by a greater efficiency in the bottling lines as well as a higher presence of PET bottles in our packaging mix, instead of aluminum cans.
 
HILA Operations
 
Cost of sales for our HILA Operations increased by 149.8% for the year ended December 31, 2003 to R$534.7 million from R$214.1 million in the same period in 2002, primarily reflecting our new international operations that were expanded during 2003. On a per hectoliter basis, cost of sales for our HILA Operations decreased by 4.0% for the year ended December 31, 2003 to R$52.2/hl from R$54.3/hl in the same period in 2002, mainly reflecting the synergies realized in connection with the transfer to Quinsa of our assets in Argentina, Paraguay and Uruguay and improvements in the general economic situation in Argentina during 2003.
 
Gross Profit
 
Gross profit increased by 16.5% for the year ended December 31, 2003 to R$4,639.6 million from R$3,983.6 million in the same period in 2002. Gross margin as a percentage of sales decreased slightly to 53.4% in 2003 from 54.4% in 2002. All improvements achieved through our revenue management initiatives were offset by lower volumes and the negative effect of our currency hedge obligations on our variable U.S. dollar-linked costs.
 
Selling and Marketing Expenses
 
Selling and marketing expenses increased by 23.3% for the year ended December 31, 2003 to R$847.1 million from R$687.2 million for the same period in 2002, primarily as a result of new HILA Operations commenced during 2003. Selling and marketing expenses for our Brazilian Operations remained almost unchanged in 2003 (R$627.9 million) compared to 2002 (R$628.5 million).
 
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Direct Distribution Expenses
 
Direct distribution expenses include product delivery charges and delivery personnel required to distribute our products. Direct distribution expenses increased by 20.7% for the year ended December 31, 2003 to R$648.6 million from R$537.4 million in the same period in 2002. Reflecting our strategy to increase the percentage of volumes of our Brazilian Operations sold through our direct distribution network, volumes sold directly represented 36.9% of total volume sold in 2003, compared to 32.6% in 2002.
 
On a per hectoliter basis, Brazilian Operations’ direct distribution expenses increased 18.4% for the year ended December 31, 2003 to R$22.2/hl from R$18.7/hl for the same period in 2002. Higher freight costs, mainly a result of higher fuel costs, along with higher fixed costs per hectoliter, were the main reasons that negatively impacted the direct distribution expenses per hectoliter. Higher fixed costs per hectoliter were primarily the result of the increase in the number of direct distribution centers combined with lower overall volumes sold, especially in the second half of 2003.
 
Volumes sold directly in our HILA Operations, mainly in Venezuela, represented 84.4% of total volumes sold in that country for the year ended December 31, 2003, compared to 82.1% in the same period in 2002. Direct distribution costs per hectoliter were R$39.4/hl in 2003, an increase of 6.3% over the same period in 2002.
 
General and Administrative Expenses
 
General and administrative expenses increased by 11.9% for the year ended December 31, 2003 to R$417.9 million from R$373.5 million in the same period in 2002, primarily as a result of HILA Operations commenced during 2003. General and administrative expenses for our Brazilian Operations were R$351.6 million in 2003, roughly in line with the R$346.4 million registered in 2002. Costs associated with the opening of new regional offices, as well as certain one-time expenses related to information technology projects, fully offset any cost reductions achieved through our initiatives to reduce general and administrative expenses.
 
Depreciation and Amortization
 
Depreciation and amortization increased by 25.5% for the year ended December 31, 2003 to R$420.0 million from R$334.6 million in the same period in 2002. Brazilian Operations’ depreciation and amortization increased by 16.9% for the year ended December 31, 2003 to R$372.9 million from R$319.0 million in 2002, reflecting the investments in our direct distribution network and sub-zero coolers, which we continue to install at strategically located high volume points of sale. During the next two to three years we will be significantly increasing our investments in our sub-zero coolers as part of our strategy to enhance our point of sale execution and to leverage our distribution efficiency. Thus, depreciation should grow proportionally. HILA Operations’ depreciation and amortization increased by 202.3% for the year ended December 31, 2003 to R$47.1 million from R$15.6 million in 2002, primarily as a result of the expansion of our international activities.
 
Provisions for contingencies
 
Net provisions for contingencies charged to the statement of operations amounted to R$187.9 million for the year ended December 31, 2003, compared to R$123.7 million charged in the same period in 2002. Provisions for contingencies with respect to Brazilian Operations were R$231.8 million in 2003, mainly comprised of: (i) R$104.9 million for labor provisions; (ii) R$77.4 million for ICMS tax credit with respect to purchases of property, plant and equipment prior to 1996, which are under dispute; (iii) R$35.2 million related to a dispute regarding whether financial income is subject to PIS/COFINS tax; and (iv) a provision of R$9.7 million related to the termination of certain third-party distributor distribution agreements.
 
Provisions for contingencies for HILA Operations were R$43.8 million, related mostly to our proportional consolidation of Quinsa.
 
Other operating income (expense), net
 
Other (net) operating expenses for the year ended December 31, 2003 was R$240.1 million, compared to income of R$199.4 million in the same period in 2002. Brazilian Operations contributed with R$230.7 million in
 
 
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expenses related to: (i) foreign exchange losses in our subsidiaries abroad (principally malting plants in Argentina and Uruguay whose functional currency is the U.S. dollar), which totaled R$128.8 million; (ii) R$195.5 million of goodwill amortization, mainly related to Antarctica, Astra and Quinsa; and (iii) R$16.5 million related to the pension cost arising from the Company’s actuarial liabilities under Brazilian GAAP. Other operating income of R$175.9 million, related to tax incentives realized by AmBev’s subsidiaries (mainly CBB), and R$16.6 million, resulting from early payment of sales tax (“ICMS”) at a discount, contributed to partially offset other operating expenses associated with our Brazilian Operations.
 
Other operating expenses for HILA Operations were R$9.4 million, mainly attributable to Quinsa’s activities.
 
Net Financial Income (Expenses)
 
Our financial income consists of realized and unrealized gains from financial instruments, foreign exchange gains (losses) on investments, financial income on cash equivalents and others. Our financial expenses consist of foreign exchange gains (losses) on loans, realized and unrealized losses from financial instruments, interests and charges on loans, taxes on financial transactions, interest on contingencies and others.
 
We enter into hedging transactions to address AmBev’s Brazilian foreign currency debt exposure, which involve cash investments in U.S. dollar-linked assets, as well as the use of swaps and derivatives. As a result of Brazilian accounting requirements, volatility in the real/U.S. dollar exchange rate and interest rates can cause significant variations in financial income and expenses.
 
Financial income for the year ended December 31, 2003 was R$601.8 million, compared to R$2,530.3 million in the same period in 2002. The effect of the appreciation of the real during 2003, resulting in losses attributable to our cash and assets linked to the U.S. dollar (R$97.2 million) in contrast to a gain registered in 2002 (R$1,007.2), as a result of the devaluation of real during 2002, more than offset the positive effect of the appreciation of the market value of certain assets during 2003, due to the decrease in the risk aversion and also lower interest rates prevailing in the market. Pursuant to Brazilian GAAP, we were not able to book an unrealized gain of R$205.9 million in the market value of certain assets, as such values exceeded the corresponding yield curve accrual values.
 
Financial expenses for the year ended December 31, 2003 were R$508.7 million, compared to R$3,277.3 million in the same period in 2002. Once again, the appreciation of the Brazilian real during 2003 accounts for this difference. During 2002, the real devaluation negatively affected the value of our U.S. dollar denominated debt. Conversely, the appreciation of the Brazilian real in 2003 reduced the value, in reais, of our U.S. dollar denominated debt.
 
Operating income
 
Operating income increased by 42.4% for the year ended December 31, 2003 to R$1,964.9 million from R$1,379.5 million in the same period in 2002. The increase in operating income was attributable primarily to the following factors: (i) increase in gross profit from our Brazilian Operations; (ii) the expansion of our international activities; and (iii) the appreciation of the Brazilian real.
 
Non-Operating income (expense), net
 
Non-operating expenses increased by 39.5% for the year ended December 31, 2003 to R$100.7 million from R$72.2 million in the same period in 2002. Brazilian Operations non-operating expenses amounted to R$80.4 million, mainly as a result of an expense of R$47.9 million related to losses on the sale of fixed assets, and expenses of R$32.6 million related to Quinsa’s share buyback programs, which, despite increasing AmBev’s stake in the Company, had a negative effect on Quinsa’s shareholders equity because of the difference between the market value of Quinsa’s shares over their book value. HILA Operations contributed with non-operating expenses of R$20.2 million.
 
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Income tax benefit (expense)
 
Our consolidated income tax and social contribution for the year ended December 31, 2003 was a charge of R$426.1 million. At the nominal tax rate of 34%, income tax for the year ended December 31, 2003 would have amounted to R$625.8 million. Our effective income tax rate in the year ended December 31, 2003 was positively affected by: (i) the benefit from tax deductible distribution of interest attributed to shareholders’ equity (R$152.7 million); (ii) tax losses arising from the previous year (R$148.0 million), primarily from the Pepsi transaction; (iii) non-taxable equity gains attributable to subsidiaries (R$59.8 million); and (iv) the write-off of goodwill in connection with the merger of a subsidiary (R$37.1 million). The losses of subsidiaries abroad not subject to taxation (R$182.9 million) negatively affected our actual tax rate.
 
Profit sharing and contributions
 
Provision for employee and management profit sharing decreased by 81.1% for the year ended December 31, 2003 to R$23.7 million from R$112.3 million in the same period in 2002. The significant decrease is primarily a result of the non-payment of performance bonuses to which certain managers and employees would have been entitled if certain corporate goals and other performance targets had been achieved in 2003. The R$23.7 million relates to financial awards distributed in accordance with our Manufacturing Excellence Program and to the proportional consolidation of Quinsa’s profit sharing program.
 
Minority interest
 
Minority shareholders in our subsidiaries shared in gains of R$2.9 million for the year ended December 31, 2003, compared to losses of R$47.4 million in 2002. This change is related to the improved performance and extension of our HILA Operations in 2003.
 
Net Income
 
Net income decreased by 6.5% for the year ended December 31, 2003 to R$1,411.6 million from R$1,510.3 million in the same period in 2002.
 
Liquidity and Capital Resources
 
Our primary sources of liquidity have historically been cash flows from operating activities and borrowings. Our material cash requirements have included the following:
 
·  
the servicing of our indebtedness;
 
·  
capital expenditures;
 
·  
our share buy-back program;
 
·  
payments of dividends and interest attributable to shareholders’ equity;
 
·  
increases in ownership of our subsidiaries or companies in which we have equity investments; and
 
·  
investments in companies participating in the brewing, soft drink and malting industries.
 
Our cash and cash equivalents and short-term investments at December 31, 2004, 2003, and 2002 were R$1,505.4 million, R$2,534.2 million, and R$3,290.0 million, respectively. The decrease in our cash position at the end of 2004 compared to the end of 2003 was principally due to the programs we launched during 2004, pursuant to which R$1,609.6 million of shares were repurchased, and the dividend payments of R$602.9 million, reflecting management’s decision to reduce the amount of cash and cash equivalents on hand in light of our increased comfort in accessing the capital markets. The decrease in the amount of our cash and cash equivalents at the end of 2003 compared to the end of 2002 was primarily a result of: (i) payment for the acquisition of our interest in Quinsa and other acquisitions; (ii) payment of dividends during the year; and (iii) capital expenditures. Proceeds from the issuance of our U.S.$500 million 10.5% senior notes in September 2003 and liquidation of certain short-term investments affected our cash position.
 
 
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We believe that cash flows from operating activities, available cash and cash equivalents and short-term investments, along with our derivative instruments and our access to borrowing facilities, will be sufficient to fund our capital expenditures, debt service and dividend payments going forward.
 
Cash Flows
 
Operating activities
 
Our cash flows from operating activities increased 35.2% to R$3,418.6 for the year ended December 31, 2004 from R$2,527.6 million for the same period in 2003 due to operational growth in our Brazilian operations and our HILA operations, and the merger of Labatt into AmBev.
 
Our cash flow from operating activities decreased 29.7% for the year ended December 31, 2003 to R$2,527.6 million from R$3,595.0 million for the year ended December 31, 2002. All the foregoing factors were partially mitigated by other transactions generating a net cash inflow of R$8.3 million in 2003.
 
Investing activities
 
Cash flows generated in our investing activities for the year ended December 31, 2004 totaled R$110.8 million, compared to cash flows used in investing activities of R$2,014.7 million for the same period in 2003. This was due mainly to (i) our decision to reduce our positions in securities in 2004; (ii) a reduction in cash used to acquire new investments compared to our acquisition of Quinsa in 2003; and (iii) the consolidation of Labatt’s initial cash position, which offset certain investment requirements. This change was partially offset by higher capital expenditures and the repurchase of shares by Quinsa during 2004.
 
For the year ended December 31, 2003 cash flows used in our investing activities totaled R$2,014.7 million compared to R$1,603.1 million for the year ended December 31, 2002. The increased cash utilized in investing activities in 2003 compared to 2002 primarily reflects the acquisition of our economic interest in Quinsa and our investments in new markets in South and Central America, such as Ecuador, Peru and Guatemala, as well as investments in our direct distribution network, mainly through the acquisition of third-party distributors.
 
Financing activities
 
Cash flows used in financing activities for the year ended December 31, 2004 amounted to R$3,433.9 million compared to R$346.7 million for the same period in 2003. This was principally due to the full amortization of R$974.7 million of a yen-denominated syndicated loan and an increase in pay-outs mainly through our share buy-back programs.
 
For the year ended December 31, 2003 cash flows used in financing activities totaled R$346.7 million, compared to R$2,912.2 million for the year ended December 31, 2002. The proceeds of certain financing, primarily the 2013 notes, as well as the cash generated from our operating activities, were used to repay R$2,510.1 million in debt in 2003.
 
As of December 31, 2004, our outstanding debt totaled R$7,810.7 million (of which R$3,443.1 million was short-term debt, including R$1,289.3 million of the current portion of long-term debt). Our debt consisted of R$1,000.9 million of real-denominated debt and R$6,809.8 million of foreign currency-denominated debt.
 
The table below shows the profile of our debt instruments:
 
 
AmBev’s Profile as of December 31, 2004 
Debt Instruments
   
2005
   
2006
   
2007
   
2008
   
2009
   
Thereafter
   
Total
 
                                                                                                             (R$ in millions, except percentages)
U.S.$ Denominated Debt (Fixed Rate)
                                           
Notional Amount
   
309.5
   
-
   
-
   
-
   
-
   
2,654.4
   
2,963.9
 
Average Pay Rate
   
9.63
%
                                   
 
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BNDES Currency Basket Debt (Fixed Rate)
                                           
U.S. $ Denominated Debt (Fixed Rate)
   
18.7
   
18.4
   
18.6
   
16.8
   
0.8
   
-
   
73.2
 
Average Pay Rate
   
3.50
%
                                   
International Debt
                                           
U.S. $ Denominated Debt (Fixed Rate)
   
495.2
   
155.9
   
151.4
   
572.5
   
-
   
281.3
   
1,656.2
 
Average Pay Rate
   
4.44
%
                                   
International Debt
                                           
Other Latin American Currency (Fixed Rate)
   
204.8
   
-
   
-
   
-
   
-
   
-
   
204.8
 
Average Pay Rate
   
9.86
%
                                   
International Debt
                                           
C$ Denominated Debt (Fixed Rate)
   
1,911.7
   
-
   
-
   
-
   
-
   
-
   
1,911.7
 
Average Pay Rate
   
4.30
%
                                   
R$ Denominated Debt (Floating Rate - TJLP)
                                           
Notional Amount
   
135.2
   
80.1
   
66.2
   
53.7
   
9.6
   
-
   
344.7
 
Average Pay Rate (TJLP +)
   
2.40
%
                                   
R$ Denominated Debt (Floating Rate - CDI)
                                           
Notional Amount
   
274.6
   
-
   
-
   
-
   
-
   
-
   
274.6
 
Average Pay Rate (% of CDI)
   
104
%
                                   
R$ Debt - ICMS (Fixed Rate)
                                           
Notional Amount
   
93.5
   
3.1
   
192.1
   
15.1
   
-
   
77.8
   
381.6
 
Average Pay Rate
   
4.99
%
                                   
Total
   
3,443.2
   
257.5
   
428.3
   
658.1
   
10.4
   
3,013.4
   
7,810.7
 
 
As of December 31, 2003, our outstanding debt totaled R$5,980.4 million (of which R$1,976.1 million was short-term debt, including R$1,427.4 million of the current portion of long-term debt). Our debt consisted of R$901.5 million of real-denominated debt and R$5,078.9 million of foreign currency-denominated debt. The weighted average annual interest rate for the short and long-term portions of the local currency-denominated debt at December 31, 2003 was 12.1% and 6.8%, and the average duration was 5 months and 2.3 years, respectively. The weighted average annual interest rate for the short and long-term portions of the foreign currency-denominated debt was approximately 7.0% and 10.5%, and the average duration was 6 months and 7.0 years, respectively.
 
As of December 31, 2002, our outstanding debt totaled R$4,486.7 million (of which R$607.4 million was short-term debt, including R$292.5 million of the current portion of long-term debt). Our debt consisted of R$988.1 million of real-denominated debt and R$3,498.6 million of foreign currency-denominated debt. The weighted average annual interest rate for the short and long-term portions of the local currency-denominated debt at December 31, 2002 was 11.6% and 8.1%, and the average duration was 6 months and 2.5 years, respectively. The weighted average annual interest rate for the short- and long-term portions of the foreign currency-denominated debt was approximately 9.9% and 9.7%, and the average duration was 5 months and 4.8 years, respectively.
 
  Restrictions on the transfer of funds fromsubsidiaries
 
Certain of Labatt’s debt agreements contain clauses that restrict the transfer of funds to related companies, including AmBev. Under the terms of these agreements, if Labatt’s leverage ratio (aggregate indebtedness to EBITDA) exceeds 3 to 1, Labatt may not distribute, in any given fiscal year, cash in excess of the following thresholds:
 
(i) EBITDA minus interest charges minus capital expenditures minus cash taxes; or
 
(ii) 100% of net income.
 
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Labatt’s current leverage ratio does not exceed 3 to 1. We do not expect these restrictions to affect our ability to meet our cash obligations.

Borrowings
 
The following tables set forth our net debt consolidated position as of December 31, 2004, 2003 and 2002:
 
 
Net Debt Consolidated Position
 
2004
2003
2002
 
LC(1)
FC(2)
Total
LC(1)
FC(2)
Total
LC(1)
FC(2)
Total
 
(R$ in millions)
Short-term debt(3)
   503.2
2,939.9
3,443.1
262.0
1,714.1
1,976.1
269.1