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• BUSINESS PORTFOLIO
(1) Millions of Mexican pesos of constant terms as of December 31, 1998 (2) Total asset share (3) Companies from the Technology Division and Corporate Services (N.A.) Not Available FINANCIAL RESULTS
GRUMA, S.A. DE C.V. AND SUBSIDIARIES Millions of Mexican pesos of constant terms as of December 31, 1998
1997 1998 VARIATION % Net sales 13,194 13,774 4.4
Gross profit 4,507 5,028 11.6
Operating income 941 1,032 9.6
Operating cash flow 4 1,511 1,619 7.2
Net income 713 654 (8.4)
Net majority income 442 417 (5.6)
Total assets 16,651 17,173 3.1
Total liabilities 6,335 7,080 11.8
Stockholder’s equity 10,316 10,092 (2.2)
Majority stockholder’s equity 7,937 7,703 (2.9)
Operating cash flow/gross interest expense 4.18 4.29 2.7
Operating cash flow per share5 4.28 4.57 6.8
Book value per share6 22.73 21.83 (4.0)
(4) Operating cash flow defined as Operating income +Depreciation and Amortization (5) Pesos over bases of 354,740,401 shares for 1997, and 354,059,496 shares for 1998 (6) Pesos over bases of 349,271,363 shares for 1997, and 353,196,619 shares for 1998
LETTER FROM THE CHAIRMAN
To our shareholders:
It gives me great pleasure to inform you that during 1998 GRUMA continued strengthening its position as a world leader in the corn flour and tortilla industry, and reported very good operating results. We had the highest sales volume and gross pro- fit in our history, 3.1 million tons and 5 billion pesos, respectively. The higher volume made it possible for GRUMA´s net sales growth to resume, with a 4% increase over 1997. Margins showed improvement with gross profit rising 12% and operating profit up 10%.
Our international operations advanced significantly, increasing sales by 10%. Gruma Corporation strengthened its leadership position in both the corn flour and the tortilla markets, showing a combined growth of 10% in sales volume over 1997, as well as an improvement of 16% in gross profit and an 18% increase in operating profit. Gruma Centro América grew its sales volume by 6% and its gross profit by 11% com- pared to 1997. Combined sales from our foreign operations increased from 52% to 55% of GRUMA´s total sales.
In Mexico, Grupo Industrial Maseca (GIMSA) reported a 6% increase in gross profit and a 5% rise in operating profit; both margins improved in spite of a slight decrease of 3% in sales volume due mostly to the federal government's ceilings on corn flour sales volumes for the production of subsidized tortillas.
On December 31, 1998, the federal government issued a decree eliminating the regulations on the corn tortilla industry. This decree ended the ceiling system for corn flour sales volume, as well as the generalized subsidy and price control of corn tortilla. This environment of totally free competition is expected to have two important results: first, resumption of the process of substituting corn flour for the traditional corn method in making tortillas because of the economic and technological benefits of corn flour; and second, a significant growth in the consumption of packaged tortilla. As a result, GIMSA is expecting to increase its sales volumes because of the superior quality of MASECA® and its recognized customer service.
Molinera de México, our joint venture with Archer-Daniels-Midland in the wheat flour industry, continues to report good results. This subsidiary had a 93% increase in sales volume in 1998. Molinera de México is the market leader in the country, with a 9% market share.
On November 20, 1998, GRUMA launched a complete line of white bread and sweet bread under the BREDDY® brand in the metropolitan area of Monterrey, Mexico. During the first six weeks of operations, sales surpassed our goals. In 1999 we expect to complete our coverage of the entire northeastern region of the country, including the states of Nuevo León, Tamaulipas, Coahuila, San Luis Potosí and Zacatecas.
5 LETTER FROM THE CHAIRMAN
In 1998, GRUMA implemented an aggressive capital investment and acqui- sition program totaling 2 billion pesos. This program provided the Company with six more plants (three tortilla plants, two wheat mills and one bread plant) and expanded the existing capacity of other plants. Additionally, we continued to modernize our information technology to achieve greater efficiency and productivity in our key management processes. Through this capital funding, GRUMA has strengthened its competitive advantages in market share, production costs and growth capacity.
Our total quality management program has also made significant progress. In 1998 eight additional plants were ISO-9000 certified. To date, 30 of our plants have been awarded this certification. Furthermore, in the United States, Gruma Corporation's Olympic plant received the California Governor's Golden State Quality Award, and three other GIMSA plants received ISO-14000 certification.
In summary, 1998 was a year of great achievement for GRUMA. Our Company increased its market shares, sales, and gross and operating profits. In ad- dition, it strengthened its position in order to take advantage of growth opportunities in the corn flour, tortilla, wheat flour and bread markets. At the same time, we main- tained the sound financial structure that allows us to continue to be the only Mexican company with an investment grade rating.
1999 will be a special year for GRUMA, not only because of the great growth opportunities that lay ahead, but also because we celebrate our 50th anniversary. During the last five decades, GRUMA has become the undisputed leader in the corn flour and tortilla industry, and successfully entered into other businesses, such as wheat flour in Mexico and bread in Central America and Mexico.
At the meeting held on February 24, 1999, Gruma, S.A. de C.V.'s Board of Directors accepted the resignation submitted by Dr. Eduardo Livas Cantú as President and Chief Executive Officer for personal reasons. At the same meeting the Office of the President was created. This office will be in charge of GRUMA's affairs under the guidance of the Chairman and of the Board of Directors. The Office of the President will be comprised of the following executives: Ricardo Alvarez-Tostado Penella, Deputy Chief Executive Officer of GRUMA, S.A. de C.V. and also Chief Executive Officer of Grupo Industrial Maseca, S.A. de C.V.; Manuel Rubiralta Díaz, Executive Vice President of Marketing and Sales of GRUMA, S.A. de C.V.; Martín Ricoy Luviano, President and Chief Executive Officer of Gruma Corporation and Javier Vélez Bautista, Chief Financial and Planning Officer of GRUMA, S.A. de C.V. This new role not only provides continuity, but also re- inforces the continuing development of the professional management structure that GRUMA began several years ago.
6 LETTER FROM THE CHAIRMAN
I would like to thank our customers and investors for their trust, as well as the mem- bers of the Board of Directors and all our personnel for their active participation and support, and I would like to reiterate that at GRUMA we are committed to a long-term dynamic and sustained growth that creates greater value for our shareholders.
Don Roberto González Barrera Chairman of the Board
7
OUR CORE BUSINESSES
AND
An ongoing
commitment to
thoroughly know our
customers, to develop
efficient manufacturing
processes and better
products, and a long-
term vision have allowed
GRUMA to acquire
valuable experiences
over half a century and
to become the market
leader in all its markets. GRUMA CORPORATION
Growing dynamically with a food item that is becoming more popular every day in the United States: the tortilla
The consumption of Mexican food in the United States continues growing dynamically, generating additional demand for tortillas and corn flour. This has been a direct result of the increasing popularity of Mexican food among mainstream consumers and of the growing Hispanic population.
A sound balance between growth and profitability
Gruma Corporation's fundamental strategy has been to reinforce its leadership in the tortilla industry, maintain- ing a sound balance between the accelerated growth of sales and profit generation. Gruma Corporation increased its market share through a broader direct dis- tribution of its MISSION® and GUERRERO® tortilla brands to stores, and of MASECA® corn flour to tortilla and chip producers, as well as retailers.
In 1998, the combined sales volume of corn flour and tortillas grew 10% over the prior year, while operating profit increased 18% and the operating margin rose to 6.9%. This is mainly a result of higher sales volumes and greater operating efficiency in the tortilla business.
As a result of this balanced growth, in June of 1998 Moody's Investors Service assigned an investment grade rating of Baa2 to one of Gruma Corporation's most important credit facilities. The rating reflects Moody's expectation that Gruma Corporation will continue to strengthen its highly competitive position in the U.S. tortilla market and will maintain a prudent financial strategy.
10 Gruma Corporation's market share in the total tortilla market in the United States is estimated at 24%. The CORN FLOUR Company has widened its clear leadership position in an POTENTIAL MARKET industry that is highly fragmented and with a substantial potential for growth. TORTILLA MARKET In the corn flour industry, Gruma Corporation has an 83% market share and a 43% share of the potential market. The greatest opportunity for growth lies in the conversion of the segment that still uses the traditional method of making tortillas from corn, which amounts GRUMA CORP. 43% to 48% of the potential market. The economic and CORN FLOUR 52% technological advantages of corn flour will enable TRADITIONAL METHOD 48% GRUMA CORP. 24% Gruma Corporation to continue its dynamic growth in this market.
TORTILLA MARKET SHARE * 84% 86% 78%
58% 56% 53% 53% 56% 48% 47%
28% 24%
Dallas Denver Houston Los Angeles Miami New York Phoenix Portland San Antonio San Diego San Francisco Seattle
* SOURCE: A.C. Nielsen; 52 weeks ending December 1998 GRUMA CORPORATION
Greater coverage means greater market share
In 1998, GRUMA took solid steps to extend its coverage into new territories by acquiring two tortilla plants in the state of Texas. Furthermore, operations were started at a new plant in Houston, and the Seattle plant is scheduled to open in the second half of 1999.
Additionally, Gruma Corporation enhanced its presence in the European market by increasing sales and the number of customers, establishing the basis for GRUMA's future growth.
At the beginning of 1999, Gruma Corporation acquired four tortilla-producing plants. One of them, located in North Carolina, has an important presence on the East Coast. The other three plants are located in the most important con- sumption centers in Texas. With these acquisitions, Gruma Corporation has strengthened its leadership position in the tortilla market in the United States and increased the num- ber of satisfied customers.
Total quality: a recognized commitment
Both the corn flour plant in Evansville, Indiana and the tortilla plant in Rancho Cucamonga, California were ISO-9000 certified in 1998.
We are proud to report that this year the Olympic tortilla plant in Los Angeles, California received the California Governor's Golden State Quality Award.
Important achievements were also made in the area of information technology. The implementation of SAP/R3 was completed at all five corn flour mills and during 1999 significant advances will be made at the tortilla plants. This will not only enable us to automate the company's processes but will also allow us to achieve greater administrative efficiency and a better use of our resources.
12 .nts. One of them, located in North Carolina, has an important presence on the East Coast. The other three plants are located in the most important consumption centers in Texas. With these acquisitions, Gruma Corporation has strengthened its leadership position in the tortilla market in the United States and increased the number of satisfied customers.
Both the corn flour plant in Evansville, Indiana and the tortilla plant in Rancho Cucamonga, California were ISO-9000 certified in 1998.
We are proud to report that this year the GRUPO INDUSTRIAL MASECA
A year of achievements and a promising future
During the year, the federal government eliminated the regulations limiting the corn dough and tortilla industry, creating enormous growth opportunities in the market for GIMSA.
On December 31, 1998, the government issued a decree that ended both the ceiling system for corn flour sales volume, and the generalized subsidy and price control of corn tortillas. The elimination of the subsidy will not have an adverse impact on lower income groups since the government has implemented more targeted welfare programs.
In the new environment of free competition, GIMSA is expecting to increase its sales volumes because of the superior quality of MASECA® and its recognized customer service.
14 MASECA®, Mexico´s leading corn flour brand
The total tortilla market in Mexico grew 1% during the last year. The estimated volume (excluding self- consumption) is 9.4 million tons, with a value of approximately 4 billion dollars. The corn flour industry had a 47% market share in the production CORN FLOUR of tortillas. POTENTIAL MARKET During 1998, MASECA® maintained its leadership position with a sales volume of 1.8 million tons, which represents 69% of the corn flour industry and 32% of the potential market. GIMSA's sales volume decreased 3% compared with 1997, mainly due to the ceilings imposed by the federal government. Operating profit increased by 5% and the operating GIMSA 32% margin improved to 15.7%, despite the reduction in CORN FLOUR 47% sales volume. TRADITIONAL METHOD 53% GIMSA's marketing strategy was focused on customer satisfaction. Additionally, the Company strengthened its sales force to improve its efficiency. This resulted in improved customer service, greater distribution and enhanced product quality. GIMSA will continue to reinforce this strategy in order to encourage traditional tortilla manufacturers to convert to corn flour consumption.
15 GRUPO INDUSTRIAL MASECA
During 1998, our milling capacity was expanded by completing the second production unit at the Veracruz plant.
GIMSA launched corn flour with vitamins and protein enriched corn flour to improve the nutritional level of the Mexican population. GIMSA was the first to develop and market these types of corn flours. Both products have a substantial growth potential since they increase the nutritional value of the tortilla with- out changing its characteristic flavor or color.
Total quality: an ongoing commitment
Our ongoing efforts to preserve the environment have resulted in important achievements. Three plants were ISO-14000 certified this year. These advances serve to reiterate our commitment to protect the environment in the communities where we have a presence.
As part of our information technology modernization program, the SAP/R3 program was successfully imple- mented at eleven of our eighteen plants. The goal is for all plants to have this system by mid-1999. GIMSA is now at the same level as the world's leading companies, operating with communication and information systems that meet the needs of the new millenium.
16
GRUMA CENTRO AMERICA
Modernizing the tortilla industry and developing new businesses with great potential
Central America is a market with substantial growth opportunity, since only 12% of the tortillas consumed in the region are made with corn flour.
During the last few years, Gruma Centro América has grown significantly, transforming the tortilla industry from the traditional method to the use of corn flour.
Substituting the traditional method of producing tortillas from corn has been our biggest challenge. We are committed to modernize the tortilla manu- facturing process by implementing specific plans to increase the use of corn flour in two market segments: the traditional tortilla producers and home use.
Our strategy has focused on: • Promoting the economic and technological benefits of corn flour over the traditional method.
• Training traditional tortilla producers in the use of corn flour, through the 100 Club Program that makes CORN FLOUR MARKET gas stoves, hand-pressing machines and other equipment available for them.
• Promoting the use of corn flour for preparing different dishes at home.
The results were very satisfactory. There was a 6% growth in corn flour sales volume in 1998. This allowed Gruma Centro América to maintain a 78% share of the GRUMA CENTRO AMERICA 78% corn flour market in the region.
In addition, during 1998 our associate company in Venezuela reported significant increases in sales volume and corn flour market share.
18 Tortillas in Costa Rica: a market rich in opportunities
In 1998 Gruma Centro América made a strategic change in its tortilla business in Costa Rica. In the past a franchise system had been used, with over 40 small manufacturing centers to cover the entire country. Production has now been centralized in a new and modern plant that pro- duces higher quality tortillas with greater operating ef- ficiency.
In addition, the logistics and distribution of other pro- ducts were redesigned in Costa Rica, with the incorpora- tion of tortillas into the daily direct store delivery system. A substantial reduction in distribution expenses was achieved, as well as greater coverage of points-of- sale. The aforementioned benefits will be even more significant in the second half of 1999.
In 1998, we undertook market research studies through which we clearly identified consumers´ preferences and established strategies aimed at meeting their needs. These strategies resulted in a 27% growth in the tortilla sales volume and an 85% share of the tortilla market in Costa Rica.
19 GRUMA CENTRO AMERICA
In 1999 we will continue to focus our efforts on identify- TORTILLA MARKET IN ing and satisfying consumer needs in order to maintain COSTA RICA our leadership position. Our vision has a clear objective: the consumer.
Bread: a new business with great potential
Since 1994, GRUMA has actively participated in the packaged bread business in Costa Rica, with a com- GRUMA CENTRO AMERICA 85% plete white bread and pastry product line under our BREDDY® brand. In only four years, GRUMA attained market leadership, with a 47% share.
Furthermore, we entered into the unpacked bread segment, offering such products as baguettes, which represents 82% of the total consumption of bread in Costa Rica. We started the distribution of frozen pre- cooked bread to small grocery stores where it undergoes the final baking process. This ensures a high quality, freshly-baked product for the consumer.
Costa Rica has been an excellent testing ground for GRUMA, where we have developed new businesses that have subsequently been successfully implemented in the larger markets of the United States and Mexico. Among the businesses originally implemented in Costa Rica include packaged tortillas, tortilla chips, white bread and pastries. This has afforded GRUMA the opportunity to test and develop products at a relatively low cost.
20
NEW BUSINESSES
GRUMA has diversified
its business portfolio by
successfully entering into
the wheat flour and
packaged bread markets.
GRUMA balances quality
with value through
product variety and
excellent customer
service. MOLINERA DE MEXICO
Wheat flour: A new field to harvest growth and profits
Mexico's wheat flour market is estimated at 3.3 million tons per year. The largest segment is the small mom- and-pop bakeries, which consumes approximately 50% of the total wheat flour. In addition, a smaller but high- ly profitable market is the retail segment, which represents 8% of the market. The wheat flour industry is characterized by many small producers operating less efficient plants.
Since 1996, GRUMA has participated in the wheat flour industry through its subsidiary Molinera de México, our joint venture with Archer-Daniels-Midland. At the beginning, the company had only two mills. Subsequently, Molinera de México implemented an ambitious expansion program and acquired five more mills, three in 1997 and two during 1998. As a result, Molinera de México is the company with the largest milling capacity in Mexico with 9% of the total.
WHEAT FLOUR MARKET
MOLINERA DE MEXICO 9%
24 Servicio: El ingrediente selecto para nuevos mercados
Service: a distinctive ingredient for new markets
During 1998, Molinera de México achieved an impressive 93% increase in sales volume, mainly due to acquisitions and our regional marketing strategy. Sales objectives were set by distribution channel, experienced personnel were hired and training programs were strengthened, especially in customer service.
Molinera de México's objective is to become the leading company in the wheat flour industry by a wide margin. We will attain this by focusing on two market segments: small bakeries and the retail customers, and by offering products and services that completely meet their needs.
Our leading brands in the retail segment are SELECTA®, DILUVIO® and MONTERREY®. PODEROSA®, BERRI® and SELECTA® are the most popular brands with our industrial customers.
25 MOLINERA DE MEXICO
World class quality: our continuing goal
Molinera de México undertook a plant modernization program in order to increase its competitive advantages and become the lowest-cost producer in the industry. High priority was given to wheat procurement and storage, as well as to efficiencies.
As a result of our total quality programs, the American Institute of Baking certified two of our mills. In ad- dition, programs have been implemented so that our other mills will also receive this recognition.
26
PRODUCTOS Y DISTRIBUIDORA AZTECA
Packaged tortillas and bread in Mexico: A significant market opportunity
GRUMA has been in the packaged tortilla business since 1994. Currently the Company operates manu- facturing facilities and direct store delivery networks in the northern region of Mexico and in Tijuana. Our product line includes corn and wheat tortillas, as well as tostadas, which are sold under the MISION® brand and have a leading share in the region.
On December 31, 1998, the federal government issued a decree that eliminated the general corn tortilla subsidy and price control. In the new competitive environment, we expect dynamic growth in the packaged tortilla market because the price difference between packaged and non-packaged corn tortillas will be reduced.
The tortilla market in Mexico is estimated at 9.4 million tons and valued at approximately 4 billion dollars, of which less than 3% are packaged tortillas. We estimate that in ten years half of the tortillas consumed in Mexico will be packaged and distributed through small grocery stores, supermarkets and convenience stores. BREDDY® a promising business with natural synergies
GRUMA successfully entered the Mexican style sweet bread market in Los Angeles, California more than ten years ago obtaining significant experiences in the bread industry. Later in 1994, GRUMA entered the packaged white bread and pastry business in Costa Rica launching our BREDDY® brand. In only four years, GRUMA became the market leader, with a 47% share. These ex- periences in the production and marketing of packaged bread have prepared GRUMA to enter larger markets.
The bread market in Mexico is estimated at ap- proximately 4.2 billion dollars, of which the packaged segment represents only 36%. Nearly twenty thousand small bakeries that produce non-packaged bread sup- ply the rest of the market.
GRUMA has accumulated valuable experiences in the manufacturing and distribution of packaged tortillas in Mexico. The inclusion of packaged bread in the distribution system will result in synergies and will give us the opportunity to participate in the attractive packaged bread market, until now supplied by only one manufacturer.
29 PRODUCTOS Y DISTRIBUIDORA AZTECA
In November 1998, GRUMA started operations at a modern bread factory in Monterrey, Nuevo León. The plant was designed to supply the northeastern region of the country, including the states of Nuevo León, Tamaulipas, Coahuila, San Luis Potosí and Zacatecas. Monterrey was selected because of its strategic advantages: it is GRUMA´s largest packaged tortilla market, has the highest rate of packaged food consumption in Mexico and an ongoing and a strong brand awareness of GRUMA´s products.
A comprehensive analysis of the consumers´ preferences, competitor and distribution channels was the basis to ensure a sound entry into the bread market. The Company launched a full line of BREDDY® white and sweet bread, supported by an aggressive promotional and advertising campaign. After six weeks, our brand had obtained a high awareness level with the consumer and sales had exceeded our initial targets.
Quality in our packaged products: A commitment to our customers
Our goal is to continue to develop the packaged tortilla and bread business with the same philosophy that has made GRUMA a leading company in all its markets: Superior product quality, a strong customer commitment, state-of-the-art technology, outstanding service and ef- ficient distribution networks.
30
CORPORATE PHILOSOPHY
VISION
To be the absolute leader in the manufacturing and marketing of corn flour and tortillas in the world, as well as one of the main processors of grain and basic grain-based food products in Mexico, Central America, Venezuela and Colombia.
MISSION
GRUMA is committed to dynamic and long-term profitable growth that maximizes value creation for shareholders, maintaining its principal focus on its core businnesses corn flour and tortillas, and ad- ditionally offering corn and wheat-based basic food products of superior quality to fully satisfy consumers. Our operations will be supported by efficient manu- facturing and marketing systems, including direct store delivery where profitable.
STRATEGIC GUIDELINES
• Offer world-class quality products and services.
• Achieve thorough knowledge and understanding of our customers.
• Enhance our brand equity.
• Focus our technological and market research on developing competitive advantages.
• Participate only in markets where long-term value creation can be achieved through economies of scale.
34 FILOSOFIA CORPORATIVA
VALUES
Long-term growth and vision Our fundamental objective is to maintain long-term sustained growth that maximizes value creation.
GRUMA's people GRUMA´s human resources are its most valuable asset. We acknowledge the need for continuous improvement of our employees and adequate balance between their professional and personal lives.
Quality and customer satisfaction GRUMA is committed to customer satisfaction through the continuous improvement of its products, processes and service, providing the best price-value relationship in our products.
Social responsibility GRUMA is committed to contributing to the social, economic and environmental well-being of the com- munities where it operates.
Excellence and integrity Excellence and integrity govern our operations and business relationships.
35 GRUMA, S.A. DE C.V. AND SUBSIDIARIES Financial Highlights by subsidiary (Millions of Mexican pesos of constant terms as of December 31, 1998)
GRUMA OTHER GRUMA CENTRO SUBSIDIARIES & 1998 GIMSA CORPORATION AMERICA ELIMINATIONS CONSOLIDATED
Net sales 5,069 6,624 959 1,122 13,774 Gross profit 1,474 2,798 306 450 5,028 Operating income 795 459 (22) (200) 1,032 Operating cash flow 1 992 683 44 (100) 1,619 Funded debt 618 630 246 4,028 5,522
GRUMA OTHER GRUMA CENTRO SUBSIDIARIES & 1997 GIMSA CORPORATION AMERICA ELIMINATIONS CONSOLIDATED
Net sales 5,428 5,953 911 902 13,194 Gross profit 1,395 2,421 276 415 4,507 Operating income 755 388 (5) (197) 941 Operating cash flow 1 938 612 65 (104) 1,511 Funded debt 388 583 241 3.519 4,731
GRUMA OTHER GRUMA CENTRO SUBSIDIARIES & VARIATIONS (%) GIMSA CORPORATION AMERICA ELIMINATIONS CONSOLIDATED
Net sales (7) 11 5 24 4 Gross profit 6 16 11 9 12 Operating income 5 18 374 2 10 Operating cash flow 1 6 12 (31) (4) 7 Funded debt 60 8 2 14 17
(1) Operating cash flow defined as Operating income. 36 OPERATING RESULTS
During 1998 GRUMA achieved the highest sales volume in the history of the Company, recording 3.1 million tons of corn flour, wheat flour, tortillas and bread. GRUMA resumed its growth showing an increase of 4% in net sales.
In 1998 GRUMA achieved the highest gross income in its history, growing 12% versus the previous year. In operating income, GRUMA showed a 10% increase with respect to 1997, improving its margin to 7.5% from 7.1% in 1997.
Net Sales
GRUMA's consolidated net sales in 1998 were 13.8 billion pesos, 4% higher than in 1997. This increase was due primarily to higher net sales in Gruma Corp., Molinera de México and Gruma Centro América. Foreign operations showed an increase in net sales of 10% versus 1997, increasing its proportion in GRUMA's consolidated sales to 55% in 1998 from 52% in 1997.
By subsidiary, in 1998, Gruma Corp.'s combined corn flour and tortilla sales volume of 1.6 billion pounds was 10% higher than in 1997 predominantly due to higher tortilla sales. In 1998 Gruma Corp. achieved net sales of 6.6 billion pesos. In dollar terms, these net sales were 670 million, an increase of 11% over the 603 million dollars reported in the same period last year.
During 1998, GIMSA's sales volume totaled 1.8 million metric tons, 3% lower than in 1997. Sales volume was affected mainly by the quota system imposed by the government for subsidized corn flour. GIMSA's revenues for 1998 were 5.1 billion pesos, 7% lower than in 1997 as a result of lower sales volume and lower corn flour prices due to lower corn prices.
37 OPERATING RESULTS
Gruma Centro América's corn flour sales volume of 90 thousand metric tons increased 6% over 1997. Gruma Centro América's net sales during 1998 were 959 million pesos or 97 million dollars, representing a 5% increase over 1997. In 1998, Molinera de México achieved sales volume of 244 thousand tons of wheat flour, showing an increase of 93% versus 1997. Net sales were 791 million pesos in 1998.
Cost of Sales
In 1998, GRUMA's cost of sales as a percentage of net sales decreased to 63.5% from 65.8% last year. GIMSA decreased its cost of sales as a percentage of net sales approximately 340 basis points, Gruma Corp. 150 basis points, Gruma Centro América 160 basis points and Molinera de Mexico 78 basis points. GIMSA's cost of sales as a percentage of sales was reduced due to lower cost of corn. The main reason for the decrease at Gruma Corp. was due to increased volume and continued ef- ficiency improvements in the tortilla business. Over all, GRUMA's cost of sales increased 1% to 8.74 billion pesos during 1998 from 8.69 billion pesos in 1997.
Gross profit
In 1998, gross profit of 5 billion pesos was 12% higher than in 1997, mostly as a result of higher gross profit in all of its subsidiaries. GRUMA's gross margin improved to 36.5% during 1998 from 34.2% in 1997.
Selling, General and Administrative Expenses
During 1998, GRUMA's selling, general and administrative expenses increased 12% to 4 billion pesos from 3.6 billion pesos during 1997. This increase was primarily driven by stronger marketing and advertising activities as well as the reinforcement of the sales teams in GIMSA and Gruma Corp.
38 OPERATING RESULTS
Gruma Centro América increased SG&A expenses related with the frozen dough for bread project and the acquisition of information systems included in the information technology modernization program. Molinera de México reported higher expenses com- pared to a year ago, reflecting acquisitions completed late 1997 and during 1998, as well as the reinforcement of the sales team. GRUMA's SG&A expenses as a per- centage of net sales increased to 29% in 1998 from 27% in 1997.
Operating Income
In 1998, GRUMA's consolidated operating income was 1 billion pesos, 10% higher than in 1997. This improve- ment was due primarily to higher operating profits in Gruma Corp. and GIMSA. The Company's operating margin of 7.5% in 1998 was 36 basis points higher than during 1997.
By subsidiary, in 1998, Gruma Corp.'s operating income increased 18% to 459 million pesos (46.5 million dollars). GIMSA's operating income of 795 million was 5% higher than in 1997. Gruma Centro América report- ed operating losses of 22 million pesos. GRUMA's "other subsidiaries", which include the packaged tor- tilla and bread operations in Mexico, reported a 200 million pesos operating loss, similar to the amount reported in 1997.
During 1998, EBITDA as a percentage of net sales was 11.8% amounting to 1.6 billion pesos, an increase of 7% versus 1.5 billion pesos in 1997.
Net Comprehensive Financing Cost
In 1998, GRUMA's comprehensive financing cost was 256 million pesos, an increase of 274 million pesos versus 1997, mostly due to a lower gain on monetary position, lower interest income and higher foreign exchange losses.
39 OPERATING RESULTS
During 1998, net interest expense of 183 million pesos increased 79 million pesos versus 1997. Net interest expense consisted of interest income of 194 million pesos minus interest expense of 377 million pesos. The increase in net interest expense was due mainly to lower interest income in GIMSA as a result of higher accounts receivable and to higher debt in GRUMA to continue with the expansion plans.
Foreign exchange loss was 60 million pesos, 76 million pesos more than foreign exchange gain of 16 million pesos in 1997.
Monetary position loss was 13 million pesos during 1998, 119 million pesos less than the monetary position gain of 107 million pesos in 1997. The reduction in the monetary position was due mainly to increases in GIMSA's monetary position resulting from higher cash balances and accounts receivable.
Other Expenses, Net
In 1998, other expenses, net, were 242 million pesos. This item reflects primarily extraordinary expenses of 188 million pesos related to the information technology modernization program for GRUMA, personnel restructuring, as well as the relocation of Gruma Corp.'s headquarter from Los Angeles to Dallas. Additionally, other expenses reflected amortization of excess acquisitions cost over book value.
Taxes and Employees' Profit Sharing
Provisions for income taxes and employees' profit sharing turned to 51 million pesos positive, as a result of an agreement between Gruma Corp. and the Technology Division to formalize the technological support received by Gruma Corp. This agreement made by suggestions of GRUMA's auditors, eliminated the risk of transfer pricing and generated a fiscal benefit.
40 OPERATING RESULTS
Net Majority Income
In 1998, total net income was 654 million pesos, 8% lower than last year. GRUMA recorded a net majority income of 417 million pesos versus 442 million pesos in 1997, a decrease of 6%. Earnings per share were 1.18 pesos in 1998.
41 FINANCIAL SITUATION
As of December 31, 1998, GRUMA's assets totaled 17.2 billion pesos, of which 4.7 billion pesos were current assets; 9.4 billion pesos represented property, plant, and equipment; and 3.1 billion pesos, other assets.
Total assets were 522 million pesos higher than the balance as of December 31, 1997, primarily reflecting higher property, plant and equipment, as a result of expansions mainly in Gruma Corp. and acquisitions in Molinera de México and the bread plant in Mexico. Cash balances decreased 1.5 billion pesos due to the expansion programs mentioned above, higher accounts receivable in GIMSA and higher corn and wheat inventories in GIMSA and Molinera de México, respectively.
Total liabilities as of December 31, 1998, increased 745 million pesos to 7.1 billion pesos from December 31, 1997, primarily due to a higher debt level to finance the expansion programs and to buy-back GIMSA and GRUMA shares.
Total liabilities consisted of 5.5 billion pesos of funded debt (5.3 billion pesos long term and 199 million pesos short term), and 1.6 billion pesos of other liabilities. Stockholders' equity as of December 31, 1998 totaled 10.1 billion pesos, 224 million pesos lower than the balance as of December 31, 1997.
Growth in EBITDA has been in line with growth in debt service, allowing GRUMA to maintain a strong interest coverage. In 1998, interest coverage measured as EBITDA divided by gross interest expense was 4.3 times and Gruma Corp.'s EBITDA to consolidated GRUMA gross interest expense was 1.8 times. GRUMA's leverage ratio (total funded debt divided by total funded debt plus stockholders' equity) as of December 1998 was 0.35:1.
42 FINANCIAL SUMMARY
GRUMA, S.A. DE C.V. AND SUBSIDIARIES (Millions of Mexican pesos of constant terms as of December 31, 1998)
Income Statement 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ‘97 VS. ‘98
Net sales 3,273 5,115 7,991 7,865 9,419 10,145 9,863 11,886 15,671 13,194 13,774 4.4% Gross profit 978 1,572 2,605 2,728 3,285 3,654 3,510 4,372 4,985 4,507 5,028 11.6% Operating expenses 471 909 1,683 2,075 2,416 2,458 2,664 3,511 3,703 3,566 3,997 12.1% Operating income 507 663 923 653 869 1,196 846 860 1,282 941 1,032 9.6% Comprehensive financial cost (income) 257 316 196 68 220 221 150 (1,515) (840) (18) 256 Other (income) expense 29 7 48 (64) (42) (85) (53) (73) 41 (109) (242) Net income before taxes and others 279 354 775 521 607 890 643 2,302 2,163 850 534 (37.3%) Net income 226 230 652 636 573 1,344 692 1,871 1,671 713 654 (8.4%) Net majority income 208 192 433 505 449 993 492 1,652 1,337 442 417 (5.6%) Earnings per share 1 2.57 1.89 3.88 1.81 6.00 4.54 1.25 1.18 (5.6%)
Balance Statement
Current assets 846 1,267 2,642 3,147 3,323 4,158 4,144 3,126 4,823 5,511 4,722 (14.3%) Working capital 2 431 360 1,406 1,936 2,052 2,039 2,241 1,873 2,349 2,513 3,232 28.6% Property, plant and equipment, net 1,627 1,785 2,800 3,682 4,544 5,487 7,891 7,809 8,017 8,505 9,352 10.0% Total assets 2,813 3,437 5,707 7,571 9,656 11,497 14,389 13,086 15,184 16,651 17,173 3.1% Operating liabilities 363 642 660 698 1,122 1,322 1,363 1,485 1,689 1,604 1,558 (2.9%) Total funded debt 727 937 2,210 3,342 4,231 4,646 6,417 6,047 3,655 4,731 5,522 16.7% Total liabilities 1,091 1,580 2,869 4,040 5,353 5,968 7,780 7,533 5,344 6,335 7,080 11.8% Stockholder’s equity 1,723 1,857 2,837 3,530 4,303 5,529 6,609 5,553 9,840 10,316 10,092 (2.2%) Majority stockholder’s equity 1,483 1,636 1,974 2,802 3,522 4,163 5,073 4,057 7,722 7,937 7,703 (2.9%) Book value per share 3 8.44 9.32 11.24 15.96 16.13 19.06 20.63 16.33 22.50 22.73 21.81 (4.0%)
Other Financial Data
Operating margin (%) 15.5 13.0 11.5 8.3 9.2 11.8 8.6 7.2 8.2 7.1 7.5 Depreciation and amortization 4 93 118 190 245 275 351 276 472 597 570 587 3.0% Operating cash flow 5 600 781 1,113 899 1,144 1,547 1,121 1,333 1,879 1,511 1,619 7.2% Current assets/Current liabilities 1.06 1.23 1.22 1.49 1.90 1.95 1.58 1.55 2.92 4.18 2.98 Total liabilities/Stockholder’s equity 0.63 0.85 1.01 1.14 1.24 1.08 1.18 1.36 0.54 0.61 0.70 Total funded debt/Capitalization 0.30 0.34 0.44 0.49 0.50 0.46 0.49 0.52 0.27 0.31 0.35
(1) Weighted average number of shares (thousands). 196,623 236,924 255,967 271,165 275,268 294,259 354,740 354,059 (2) Working capital defined as accounts receivable, net plus inventories minus trade accounts payable. (3) Number of shares (thousands). 175,570 175,570 175,570 175,570 218,270 218,383 245,954 248,385 343,123 349,271 353,197 (4) Depreciation and Amortization affecting Operating income. (5) Operating cash flow defined as Operating income + Depreciation and Amortization.
43 BOARD OF DIRECTORS
Roberto González Barrera Founder and Chairman of the Board
Allen Andreas Juan Antonio González Moreno Craig Hamlin Carlos Hank Rhon Roberto Hernández Ramírez Juan Manuel Ley López Eduardo Livas Cantú Bernardo Quintana Isaac Alfonso Romo Garza Adrián Sada González
Roberto González Barrera is the founder and Chairman of the Board. Since 1992 Mr. González has been a shareholder and President of the Board of Directors of Grupo Financiero Banorte, S.A. de C.V. Mr. González was a member of the board of directors of Grupo Financiero Serfín, S.A. de C.V. and also of Nacional Financiera, S.N.C. Mr. González is the founder and President of Patronato al Fomento Educativo y Asistencial de Cerralvo A.B.P., an institution of regional development, and he also participates in other social and cultural development organizations.
44 OFFICE OF THE PRESIDENT
Ricardo Alvarez-Tostado Penella is the Deputy Chief Executive Officer of GRUMA, S.A. de C.V. and also Chief Executive Officer of Grupo Industrial Maseca, S.A.de C.V. He joined the Company in October of 1997. Mr. Alvarez-Tostado previously worked for Laboratorios Schering-Plough, S.A. de C.V. for 15 years, where he served as Vice-President, Chief Executive Officer and in other senior positions. He has also worked for Laboratorios Smith-Kline. Mr. Alvarez- Tostado holds a B.S. in Commercial Relations from the Universidad del Valle de México.
Manuel Rubiralta Díaz is Executive Vice President of Marketing and Sales for GRUMA, S.A. de C.V. He joined the Company in 1998. Mr. Rubiralta previously worked as Commercial Vice-President of Grupo Televisa, for PepsiCola Internacional Mexico, for Cervecería Cuauhtémoc-Moctezuma and in several other executive positions. He holds a B.S. in Business Administration from the Universidad Nacional Autónoma de México and has studies in Marketing from the U.S.A., France and England.
Martín Ricoy Luviano is the President and Chief Executive Officer of Gruma Corporation. Mr. Ricoy joined the Company in 1997, having previously held executive positions with Kayser Roth, Campbell Soup, Ralston, Purina and Crown Cork. Mr. Ricoy holds a B.A. in Business Administration from the University of Notre Dame and holds an M.B.A. from the University of Pennsylvania's Wharton School.
Javier Vélez Bautista is the Chief Financial and Planning Officer of GRUMA S.A. de C.V. Mr. Vélez has been with GRUMA for eight years. He was Chief Financial Officer of Gruma Corporation from 1991 to 1995. Mr. Vélez previously worked for Booz-Allen & Hamilton, and at Fertilizantes Mexicanos as Chief Financial Officer. He received an M.B.A. from the University of Pennsylvania's Wharton School and a B.A. in Industrial Engineering from the Universidad Iberoamericana, in Mexico City.
45 MAIN EXECUTIVES
Corporate
Guillermo Morales Elcoro is the Chief Administrative Officer of the Company. Mr. Morales has been with the Company for seven years. He served as Controller Vice- President of the Company from 1991 to 1997. Previously, Mr. Morales worked at Cementos Mexicanos as Accounting Manager, as well as for Grupo Alfa in several positions. He holds two B.A. degrees, one in Accounting and the other in Administration, both from the Instituto Tecnológico y de Estudios Superiores de Monterrey, and an M.B.A. from the University of Texas at Austin.
Juan Quiroga García is the Internal Auditing and Tax Officer. Mr. Quiroga has been with GRUMA for 26 years. During this time, he has served as Controller and Internal Auditor of the Company. He holds a C.P.A. degree from the Universidad Autónoma de Nuevo León.
Manuel Rubio Portilla is the Chief Technology Officer of GRUMA. He joined the Company in 1965 and during these 34 years has developed 40 patents for the process, as well as machinery for the corn flour and tortilla industry. Previously he was the Chief Executive Officer of Nickel Processing Corporation and of Darr Oliver. He holds a B.S. degree in Chemical Engineering and a Masters degree. He also holds a B.S. degree in Mechanical Engineering from the Universidad de Oriente de Santiago of Cuba.
Salvador Vargas Guajardo is the General Counsel of the Company. Mr. Vargas joined the Company approximately two years ago. He was Senior Partner in the law firm Rojas-González-Vargas-de la Garza y Asociados from 1990 to 1996. Dr. Vargas earned a Ph.D. in Commercial Law from the Universidad Complutense of Madrid, Spain, Masters degree in Corporate and International Law from the University of Illinois and a Masters degree in Comparative Law from the New York University.
46 MAIN EXECUTIVES
Operating
Pedro Garza Orozco is the Chief Operating Officer of Molinera de Mexico, S.A. de C.V.. Mr. Garza has been with GRUMA for five years. He served as Chief Operating Officer for Central American Operations from 1992 to 1994. Previously, he worked for PepsiCo Corp. and Grupo Gamesa for four years and for Procter & Gamble for nineteen years.
Oscar Rojas Vergara is the Chief Operating Officer of Grupo Productos y Distribuidora Azteca, S.A. de C.V. Mr. Rojas has been with GRUMA for six years, having previously worked for PepsiCo Corp. for 21 years, as well as for Troika Mexico, Beecham Mexico and Kraft General Foods. He received a B.A. in Accounting from the Instituto Superior de Comercio in Santiago, Chile, and a M.B.A. from the Universidad Federal Rio Grande Do Sul, Brazil.
Joaquín Rubio Lamas is the Chief Operating Officer of Grupo Industrial Maseca, S.A. de C.V. Mr. Rubio has been with GRUMA for 18 years, having previously worked as President of the U.S. Corn Milling Operations, as well as in other senior positions in the Company. He received a B.A. in Administration from the Universidad Regiomontana.
Percy Roy Wever Sempé is the Chief Operating Officer of Gruma Centro América. Mr. Wever has been with GRUMA for five years, having previously worked for Embotelladora Mariposa (PepsiCo Guatemala) for three years. He received a B.A. in Industrial Engineering from Northeastern University in Boston, Massachusetts.
47
GRUMA, S.A. DE C.V. AND SUBSIDIARIES AUDITED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997
CONTENTS
2 Report of independent accountants
3 Consolidated balance sheets
5 Consolidated statements of income
6 Consolidated statements of changes
in stockholders’ equity
8 Consolidated statements of changes
in financial position
9 Notes to consolidated financial statements Humberto Murrieta Necoechea Contador Público
Mexico City, March 15, 1999
To the Stockholders’ Meeting of Gruma, S.A. de C.V.:
In my capacity of statutory examiner (comisario) and in compliance with what is provided for in Article 166 of the Mexican Corporate Law and with the bylaws of Gruma, S.A. de C.V., I ren- der to you my report on the veracity, adequacy and reasonableness of the financial information that the Board of Directors has presented to you in relation to the progress of the Company for the year ended December 31, 1998, which shows a net profit in the amount of 417,285 thousand of Mexican pesos.
I have attended the Stockholders’ Meetings and Board of Directors’ Meetings to which I have been summoned and have obtained from the directors and administrators the information about the operations, documentation and records that I considered necessary to examine. My review has been made in accordance with generally accepted auditing standards in Mexico.
In my opinion, the accounting and reporting criteria and policies followed by the Company and considered by the administrators to prepare the financial information, presented by them to this Meeting, are adequate and sufficient and were applied on a basis consistent with those of the preceding year; therefore, that information reflects veraciously, reasonably and suffi- ciently the financial position of Gruma, S.A. de C.V., as of December 31, 1998, as well as the results of its operations, the changes in stockholders’ equity and the changes in the financial position for the year then ended, in conformity with generally accepted accounting principles in Mexico.
Yours truly,
C.P. Humberto Murrieta Necoechea Comisario PricewaterhouseCoopers Condominio Losoles D-21 Av. Lázaro Cárdenas Poniente 2400 66270 Garza García, N.L. Telephone (8) 152 2000 Fax (8) 363 3483
REPORT OF INDEPENDENT ACCOUNTANTS
Monterrey, N.L., Mexico, February 18, 1999
To the Stockholders of Gruma, S.A. de C.V.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated state- ments of income, changes in stockholder´s equity and changes in financial position present fairly, in all material respect, the financial position of Gruma, S.A. de C.V. and Subsidiaries at December 31, 1998 and 1997, and the results of their operations, the changes in stockholder´s equity, and the changes in their financial position for the years then ended, in conformity with generally accept- ed accounting principles in Mexico. These consolidated financial statements have been prepared in accordance with generally accepted accounting principles in Mexico and are the responsibility of management of Gruma, S.A. de C.V. ; our responsibility is to express an opinion on these finan- cial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards in Mexico, which are substantially the same as those followed in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
Pricewaterhouse Coopers
Francisco J. Inzunza GRUMA, S.A. DE C.V. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 (Expressed in thousands of Mexican pesos of constant purchasing power as of December 31, 1998) (Notes 1 and 2) ASSETS Current: 1998 1997 Cash and cash equivalents Ps. 327,361 Ps. 1,852,348 Restricted cash (Note 11) 4,851 83,391 Accounts receivable, net (Note 3) 1,773,242 1,336,376 Refundable taxes (Note 3) 206,919 156,470 Inventories (Note 4) 2,262,992 1,919,800 Prepaid expenses 146,581 162,704 Total current assets 4,721,946 5,511,089 Investment in common stock (Note 5) 1,270,382 1,047,404 Property, plant and equipment, net (Note 6) 9,351,930 8,505,441 Intangibles, net (Note 7) 967,364 804,824 Excess of cost over book value of subsidiaries acquired, net 656,737 609,104 Other assets (Note 8) 204,170 173,169 Total assets Ps. 17,172,529 Ps. 16,651,031
LIABILITIES Current: Bank loans (Note 9) Ps. 129,383 Ps. 42,178 Current portion of long-term debt (Note 9) 69,099 98,713 Trade accounts payable 529,786 436,850 Accrued liabilities and other payables 852,859 705,859 Income taxes payable - 25,682 Employees’ statutory profit sharing payable 3,470 7,606 Total current liabilities 1,584,597 1,316,888 Long-term debt (Note 9) 5,323,753 4,590,048 Deferred income taxes (Note 15) 133,601 395,159 Deferred employees’ statutory profit sharing (Note 15) 14,691 12,001 Other liabilities 23,604 20,916 Total long-term liabilities 5,495,649 5,018,124 Total liabilities 7,080,246 6,335,012
Commitments and contingencies (Note 11)
STOCKHOLDERS’ EQUITY Majority interest (Note 12): Common stock 2,944,805 2,904,237 Restatement of common stock 3,517,757 3,510,041 6,462,562 6,414,278 Additional paid-in capital 2,379,227 2,383,098 8,841,789 8,797,376 Deficit from restatement (7,026,024) (6,529,430) Retained earnings (Note 12–C): Prior years 5,063,566 4,877,211 Net income for the year 417,285 442,234 Foreign currency translation adjustments (Note 12-E) 406,254 350,006 Total majority interest 7,702,870 7,937,397 Minority interest 2,389,413 2,378,622 Total stockholders’ equity 10,092,283 10,316,019 Total liabilities and stockholders’ equity Ps. 17,172,529 Ps. 16,651,031
The accompanying notes are an integral part of these consolidated financial statements.
3 GRUMA, S.A. DE C.V. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 (Expressed in thousands of Mexican pesos of constant purchasing power as of December 31, 1998, except per share amounts) (Notes 1 and 2)
1998 1997 Net sales (Note 13) Ps. 13,773,818 Ps. 13,194,305 Cost of sales (8,745,517) ..(8,687,509) Gross profit 5,028,301 4,506,796
Selling, general and administrative expenses (3,996,738) (3,565,855) Operating income 1,031,563 940,941
Comprehensive financing income (cost), net: Interest expense (377,275) ..(366,687) Interest income 193,951 262,024 Monetary position (loss) gain, net (12,591) 106,698 Foreign exchange (loss) gain, net (Note 16-A) (59,826) 15,741 (255,741) 17,776 Other expense, net (Note 14) (242,423) .. (108,633)
Income before income taxes, employees’ statutory profit sharing, equity in earnings of associated companies, extraordinary item and minority interest 533,399 ..850,084 Income taxes (Note 15): Current (182,220) (192,447) Deferred242,301 . .... (5,712) 60,081.. ...(198,159) Employees’ statutory profit sharing (Note 15): Current (5,367) ..(8,080) Deferred (3,317) (534) (8,684) (8,614)
Income before equity in earnings of associated companies, extraordinary item and minority interest 584,796 ..643,311
Equity in earnings of associated companies, net 68,757 86,463
Extraordinary loss on early extinguishment of debt - ..(16,516)
Income before minority interest 653,553 713,258
Minority interest (236,268) .(271,024)
Majority net income Ps. 417,285 Ps. 442,234
Earnings per share Ps. 1.18 Ps. 1.25
Weighted average shares outstanding (thousands) 354,059 ..354,740
The accompanying notes are an integral part of these consolidated financial statements.
5 GRUMA, S.A. DE C.V. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 (Expressed in thousands of Mexican pesos of constant purchasing power as of December 31, 1998, except share amounts) (Notes 1 and 2)
Common stock (Note 12 A) Number of Additional paid-in Deficit from shares (thousands) Amount capital restatement
Balances at December 31,1996 343,123 6,326,747 2,159,043 (6,108,366)
Appropriation of prior year net income
Shares issued under executive stock purchase plan 900
Stock and minority interest dividends 6,841 118,551 225,391
Net sales of common stock (1,593) (31,020) (1,336)
Issuance of subsidiaries’ stock
Recognition of inflation effects for the year (421,064)..
Foreign currency translation adjustments
Net income for the year
Balances at December 31, 1997 349,271 6,414,278 2,383,098 (6,529,430)..
Appropriation of prior year net income
Stock and minority interest dividends 5,810 120,285
Net sales of common stock (1,884) (72,001) (3,871)
Issuance of subsidiaries’ stock
Recognition of inflation effects for the year (496,594)..
Foreign currency translation adjustments
Net income for the year
Balances at December 31, 1998 353,197 Ps. 6,462,562 Ps. 2,379,227 Ps. (7,026,024)
The accompanying notes are an integral part of these consolidated financial statements.
6 Retained earnings Foreign currency (Note 12 C) translation Total Net income adjustments Total majority stockholders’ Prior years for the year (Note 12 E) interest Minority interest equity
3,697,906 1,346,909. 296,169 7,718,408 2,133,535 9,851,943
1,346,909 (1,346,909). --- -. -. - (343,942) -.. (100,495) (100,495) (39,723) (72,079) 8,215 ..(63,864) -. 75,436 75,436 216,061 (205,003) (9,093) (214,096) 53,837 53,837 - 53,837 442,234. 442,234 271,024 713,258
4,877,211 442,234. 350,006 7,937,397 2,378,622 10,316,019
442,234 (442,234).. --- (120,285) - (60,798) (60,798) .(3,501) (79,373) (21,545) (100,918).
- 166,029 166,029 .(132,093) (628,687). (309,163) (937,850). 56,248 56,248... -...... 56,248.. 417,285. 417,285 236,268 653,553
Ps. 5,063,566 Ps. 417,285. Ps. 406,254 Ps. 7,702,870 Ps. 2,389,413 Ps. 10,092,283
7 GRUMA, S.A. DE C.V. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 (Expressed in thousands of Mexican pesos of constant purchasing power as of December 31, 1998) (Notes 1 and 2)
1997 Operating activities: 1998 Net income Ps. 417,285 Ps. 442,234 Minority interest 236,268 271,024 Consolidated income 653,553 713,258 Extraordinary loss on early extinguishment of debt - 16,516 653,553 729,774
Adjustments to reconcile net income to net resources provided by operating activities: Depreciation and amortization 653,881 642,228 Equity in earnings of associated companies, less dividends received (68,757) (86,463) Deferred income taxes and employees’ statutory profit sharing (238,984) 6,246 Seniority premium 8,409 3,488 1,008,102 1,295,273 Changes in working capital: Restricted cash 78,540 50,990 Accounts receivable, net (499,841) (169,253) Inventories (569,905) (230,551) Prepaid expenses 2,772 (28,990) Trade accounts payable 90,588 17,464 Accrued liabilities and other payables 144,382 (60,041) Income taxes and employees’ statutory profit sharing (47,058) (49,598) (800,522) (469,979) Net resources provided by operating activities 207,580 825,294
Financing activities: Proceeds from bank loans and long-term debt 2,479,741 3,374,426 Repayment of bank loans and long-term debt (1,769,267) (2,341,280) Proceeds from issuance of subsidiaries’ stock 166,029 75,436 Purchases of Company’s common stock (100,918) (63,864) Dividends paid by subsidiary to minority stockholders (60,798) (100,495) Other 31,028 158,154 Net resources provided by financing activities 745,815 1,102,377 Investing activities: Purchases of property, plant and equipment (1,540,895) (1,097,008) Purchases of new plants (125,060) (61,584) Deferred assets (448,534) (213,079) Investment in common stock (325,124) (88,042) Other (38,769) 33,097 Net resources used in investing activities (2,478,382) (1,426,616) Net (decrease) increase in cash and cash equivalents (1,524,987) 501,055 Cash and cash equivalents at beginning of year 1,852,348 1,351,293 Cash and cash equivalents at end of year Ps. 327,361 Ps. 1,852,348
The accompanying notes are an integral part of these consolidated financial statements.
8 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997 (Expressed in thousands of Mexican pesos of constant purchasing power of December 31, 1998, except where otherwise indicated)
1. ENTITY AND NATURE OF BUSINESS
Gruma, S.A. de C.V. (“Gruma”), a Mexican corporation, is a holding company whose subsidiaries are located in Mexico, the United States, and Central America. These subsidiaries are primarily engaged in manufacturing and distributing corn flour, tortillas, bread and other related products. The Company and its subsidiaries are herein collectively referred to as “the Company”.
2. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in Mexico.
A) BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Gruma and all of its subsidiaries. All intercompany balances and transactions have been eliminated from the consolidated financial statements..
The principal subsidiaries of the Gruma are:
Grupo Industrial Maseca, S.A. de C.V. and subsidiaries Gruma Corporation and subsidiaries Gruma Centro América, S.A. and subsidiaries Productos y Distribuidora Azteca, S.A. de C.V. and subsidiaries Desarrollo Industrial y Tecnológico, S.A. de C.V. and subsidiaries Molinera de México, S.A. de C.V. and subsidiaries Asesoría de Empresas, S.A. de C.V. Transporte Aéreo Técnico Ejecutivo, S.A. de C.V. Inmobiliaria Residencial San Pedro, S.A. de C.V. and subsidiaries
At December 31, 1998, Gruma owned all the capital stock of the above mentioned entities, except for Grupo Industrial Maseca, S.A. de C.V. and Molinera de México, S.A. de C.V., in which Gruma’s own- ership interest represents 70.59 % and 60.00%, respectively.
B) USE OF ESTIMATES
The preparation of the financial statements in conformity with generally accepted accounting prin- ciples requires management to make certain estimates and assumptions that affect the amounts recorded for certain assets and liabilities and certain revenues, costs and expenses at the dates and for the periods being reported. The actual results may differ from these estimates.
C) FOREIGN CURRENCY TRANSLATION ADJUSTMENTS
Effective January 1, 1997, the financial statements of foreign subsidiaries are restated for the effects of inflation and translated to Mexican pesos of constant purchasing power as of December 31, 1998 applying the provisions of Bulletin B-15, as follows:
9 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
¥ Financial statements are restated to year-end constant local currencies following the provisions of Bulletin B-10, applying the General Consumer Price Index (“GCPI”) from the foreign coun- try, which reflects the change in purchasing power of the local-currency in which the sub- sidiary operates.
¥ Once financial statements are restated, assets, liabilities, income and expenses are translated to Mexican pesos applying the exchange rate in effect on December 31, 1998. The effects of trans- lation are recognized as a component of equity entitled “Foreign Currency Translation Effects” (Note 12-E).
D) RECOGNITION OF THE EFFECTS OF INFLATION
The consolidated financial statements of Gruma have been restated to recognize the effects of inflation and are expressed in thousands of Mexican pesos of constant purchasing power as of December 31, 1998, determined as follows:
¥ For comparability purposes, financial statements as of and for the year ended December 31, 1997 have been restated to Mexican pesos by utilizing a weighted average restatement factor, which considers the relative total sales contribution by country for the year ended December 31, 1997 and the corresponding inflation and exchange rate fluctuations since December 31, 1997.
¥ The consolidated statements of income and changes in stockholders’ equity for the year ended December 31, 1998 were restated applying GCPI factors from the country in which the sub- sidiary operates, applied to periods in which the transactions occurred.
¥ The consolidated statements of changes in financial position present, in Mexican pesos of constant purchasing power, the resources provided by or used in operating, financing and investing activities.
¥ The factors used to recognize the effects of inflation were:
Weighted average Year NCPI factor restatement factor 1998 18.61% 21.52% 1997 15.72% 33.51%
The methodology used to restate financial statement items is as follows:
¥ Restatement of non-monetary assets
Inventory and cost of sales are restated using the replacement cost method. As set forth in Note 2-I, effective January 1, 1997 property, plant and equipment is restated using the National Consumer Price Index (“NPCI”) factors, except for machinery and equipment of foreign origin which is restated on the basis of a specific index composed of the GPCI factor from the foreign country and the devaluation of the Mexican peso against the foreign currency. ¥ Restatement of common stock and retained earnings Restatement of common stock and retained earnings is determined by applying NCPI factors from the dates on which capital was paid-in and earnings were generated, and reflect the amounts necessary to maintain the stockholders’ investment at the purchasing power of the
10 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
original amounts. The restatement of these items is included within the related stockholders’ equi- ty captions.
¥ Deficit from restatement
Deficit from restatement primarily represents the difference between the replacement cost values or specific index restatement of non-monetary assets as described above and the historical cost of those assets restated for inflation, as measured by NCPI factors and GCPI factors for foreign sub- sidiaries.
¥ Monetary position gain
Monetary position gain represents the inflationary effect, measured by NCPI and GCPI factors, on the net balance of monetary assets and liabilities at the beginning of each month as expressed in the local currency.
E) FOREIGN CURRENCY TRANSACTIONS
Foreign currency transactions are recorded at the exchange rate prevailing on the dates the transac- tions are entered into and settled. Assets and liabilities denominated in foreign currencies are trans- lated into Mexican pesos at the exchange rate in effect at the balance sheet dates. Currency exchange fluctuations are credited or charged to income, except those described below.
The effects of translation arising from foreign currency denominated liabilities which are accounted for as a hedge of the Gruma’s net investment in foreign subsidiaries are recognized as a component of equity entitled “Foreign Currency Translation Effects”.
F) CASH AND CASH EQUIVALENTS
All highly liquid investments with original maturities of three months or less at the date of purchase are considered to be cash equivalents and are stated at cost, which approximates market value.
G) INVENTORIES (Note 4) AND COST OF SALES
Inventories are stated at the lower of replacement cost or market. Replacement cost is determined by the last purchase price or production cost. Cost of sales is determined from replacement costs calcu- lated for the month in which inventories are sold.
H) INVESTMENT IN COMMON STOCK (Note 5)
Investments in common stock with ownership between 10% and 50% of the investees’ voting stock are accounted for by the equity method. The excess of cost over book value of an investment in common stock is restated by NCPI factors. The restated amount is amortized based on the straight-line method, over a period not to exceed 20 years.
I) PROPERTY, PLANT AND EQUIPMENT, NET (Note 6)
Effective January 1, 1997, the Company adopted the “Fifth Amendment of Bulletin B-10 - Modified” (Fifth Amendment) issued by the Mexican Institute of Public Accountants. The Fifth Amendment eliminates the use of replacement cost for property plant and equipment. The net replacement cost as of December 31, 1996 became the basis for future restatements. Under the Fifth Amendment, the Company restated all property plant and equipment utilizing the NCPI factors with the exception machinery and equipment of foreign origin which is restarted on the basis of a specific index
11 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
composed of the GPCI from the foreign country and devaluation of the Mexican peso against the foreign currency.
Depreciation expense is calculated based on the net book value less salvage value, using the straight-line method over the estimated useful lives of the assets. Useful lives of the assets are as follows:
Years Buildings 30 - 53 Machinery and equipment 3 - 27
Maintenance and repairs are expensed as incurred. Costs of major replacements and improve- ments are capitalized. Comprehensive financing cost, including interest expense, currency exchange fluctuations and monetary position of the related debt for major construction projects, is capitalized as part of the assets during the construction period. When assets are retired or otherwise disposed of, the replacement cost and accumulated depreciation are removed from the appropri- ate accounts and any gain or loss is included in “Other Expense, Net”.
Direct internal and external costs related to the development of internal use software are capitalized and will be amortized over the estimated useful life beginning when such software is ready for its intended use.
J) INTANGIBLES, NET (Note 7)
Intangibles are restated using NCPI factors. Amortization expense is computed on the restated values, based on the straight-line method, over a period of 5 to 20 years.
Expenses incurred during stages dedicated to the beginning of industrial and commercial opera- tions are capitalized as preoperating expenses. This capitalization stage concludes when the Company begins its commercial activities. Preoperating expenses are amortized by the straight- line method over a period not to exceed 12 years.
The excess of cost over book value of subsidiaries acquired is restated using the NCPI factors. Amortization expense is computed based on the restated values using the straight-line method, over a period not to exceed 20 years. The Company periodically reviews the realization of its excess of cost over book value of subsidiaries acquired based on estimated gross undiscounted cash flows from the related assets. In the event that the gross undiscounted cash flows exceed the carrying amounts, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair value of the assets.
K) SENIORITY PREMIUM PLANS AND INDEMNITIES (Note 10)
Seniority premiums, to which the personnel of Mexican companies are entitled after 15 years of service, are charged to income as determined by annual actuarial valuations. Indemnities to which Mexican workers may be entitled in the case of dismissal, under certain circumstances established by Mexican Labor Law, are charged to income when they become payable.
L) REVENUE RECOGNITION
Sales are recognized when goods are shipped. Complementary revenue (Note 13) is recognized when corn flour subject to complementary revenue is sold.
12 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
M) INCOME TAXES AND EMPLOYEES’ STATUTORY PROFIT SHARING (Note 15)
Income taxes and employees’ statutory profit sharing are recorded based on the partial liability method, which recognizes the deferred tax effects of identifiable and non-recurring temporary differences between financial and taxable income. The income tax benefit from tax loss carryforwards is recorded in the year in which such carryforwards are used.
N) EARNINGS PER SHARE
Earnings per share is computed by dividing majority net income for the year by the weighted average number of common shares outstanding during the year.
3. ACCOUNTS RECEIVABLE, NET AND REFUNDABLE TAXES
Accounts receivable, net are comprised of the following as of December 31: 1998 1997 Trade accounts receivable Ps. 1,559,298 Ps. 1,082,934 Allowance for doubtful accounts (60,727) (52,887) 1,498,571 1,030,047 Related parties 61,396 67,354 Employees 22,460 32,491 Notes receivable 41,973 61,414 Other debtors 148,842 145,070 Ps. 1,773,242 Ps. 1,336,376
Refundable taxes are comprised of the following as of December 31: 1998 1997 Value-added tax Ps. 121,338 Ps. 132,496.. Income taxes 48,949 3,497.. Production and services taxes 36,632 20,477. Ps. 206,919 Ps. 156,470.
4. INVENTORIES
Inventories consist of the following as of December 31: 1998 1997 Finished products Ps. 164,618 Ps. 140,385 Production in process 36,581 42,198 Raw materials (mainly corn) 1,829,698 1,498,472 Inventory in transit 192,964 188,793 Spare parts and other 30,544 23,563 Advances to suppliers and other 8,587 26,389 Ps. 2,262,992 Ps 1,919,800
13 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
5. INVESTMENT IN COMMON STOCK
Investment in common stock is composed primarily of 9.8% of the common stock of Grupo Financiero Banorte, S.A. de C.V. and subsidiaries (“GF Banorte”), which is a financial institution regulated by the rules and accounting practices of the CNBV ( Comisión Nacional Bancaria y de Valores ).
Investments in common stock, which are accounted for by the equity method, are comprised of the following as of December 31:
1998 1997 Ownership GF Banorte: Book value Ps. 620,891 Ps. 570,681 9.8% Excess of cost over book value, net 284,126 364,464 905,017 935,145 Convertible debentures in GF Banorte 42,500 51,646 Derivados de Maíz Seleccionado Demaseca, S. A 202,146 45,728 50.0% Harinera de Monterrey, S.A. de C.V. 106,375 - 40.0% Other 14,344 14,885 Ps. 1,270,382 Ps. 1,047,404
The convertible debentures in GF Banorte bear interest at TIIE or CETES rates plus an additional two percentage points, payable each 28 days, and mature in December 2002.
6. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net consists of the following as of December 31:
1998 1997 Land Ps. 668,457 Ps. 585,709 Buildings 2,542,269 2,196,348 Machinery and equipment 8,435,435 8,348,657 Construction in progress 640,169 73,587 Software 415,577 102,762 Advances to suppliers 26,939 113,895 Other 229,066 74,254 12,957,912 11,495,212 Accumulated depreciation (3,605,982) (2,989,771) Ps. 9,351,930 Ps. 8,505,441
For the years ended December 31, 1998 and 1997, property, plant and equipment include capitalized comprehensive financing cost of Ps.51,216 and Ps.3,886, respectively. Depreciation expense for the years ended December 31, 1998 and 1997 amounted to Ps.541,890 and Ps.538,862, respectively.
7. INTANGIBLES, NET
Intangibles, net are comprised of the following as of December 31: 1998 1997 Covenants not to compete Ps. 571,804 Ps. 560,360 Preoperating expenses 240,189 148,181 Debt issue costs 85,429 79,079 Research of new projects 44,030 37,783 Patents 117,523 49,564 Other 86,124 73,842 1,145,099 948,809 Accumulated amortization (177,735) (143,985) Ps. 967,364 Ps. 804,824 14 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
8. OTHER ASSETS
Other assets as of December 31, consist of the following: 1998 1997 Trust funds for research and development of technology Ps. 170,318 Ps. 137,185 Long-term notes receivable 19,695 17,967 Guaranty deposits 14,157 18,017 Ps. 204,170 Ps. 173,169
9. SHORT-TERM BANK LOANS AND LONG-TERM DEBT
Short-term bank loans and long-term debt as of December 31 are summarized as follows:
1998 1997 Eurobonds denominated in U.S. dollars, maturing in October 2007; and bearing interest annually at a rate of 7.625% Ps. 2,470,000 Ps. 2,454,703 Eurobonds denominated in U.S. dollars, maturing in March 1998; and bearing interest annually at a rate of 9.75% - 1,227,352 Loans in U.S. dollars, which are supported by revolving credit agreements terminating in 2001. Loans under these agreements bear variable interest rates in effect at the dates the advances are made (from 6.12% at December 31, 1998) 1,185,600 392,753 Loans in U.S. dollars, which are supported by revolving credit agreements terminating through 2001. Loans under these agreements bear variable interest rates in effect at the dates the advances are made (from 7.43% to 8.90% at December 31, 1998) 1,022,774 - Loans in U.S. dollars bearing interest at annual rates from 5.2% to 7.96% with annual principal installments from 1999 through 2009. The majority of these loans have been collateralized by fixed assets of subsidiaries for approximately Ps.321,298 393,827 344,111 Loans which are supported by revolving credit agreements terminating through 2001, bearing interest at annual rates of TIIE plus 1.90% 154,331 - Short-term bank loans in U.S. dollars dollars bearing interest at annual variable rates 129,383 - Loans in U.S. dollars bearing interest at annual rates of 9.52% (payable semi-annually) with principal installments from 1999 through 2002 121,623 223,761 Loans in U.S. dollars due in June, 2002, bearing interest at annual rates of Libor plus 4.5% 43,225 55,231 Loans in U.S. dollars bearing interest at annual variable rates of 7.5% tp 10.5% due between 1999 and 2000 - 15,671 Loans in Honduran lempiras, bearing interest at annual rates ranging from 19.0% to 32.0%. - 12,973
15 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1998 1997
Loans in U.S. dollars with annual variable interest rates and semi-annual payments due through 1999 1,472 4,384 5,522,235 4,730,939 Short-term bank loans (129,383) (42,178) Current portion of long-term debt (69,099) (98,713) Long-term debt Ps. 5,323,753... Ps.. 4,590,048
At December 1998, the Company has long-term credit agreements (two to three years) for a maximum amount of U.S.$234 million (Ps.2,311,920), bearing interest at variable rates. One line of credit for U.S.$120 million (Ps.1,185,600) requires a commitment fee of 1/2% per annum over the unused amounts. Management intends to use these lines of credit to fund the payment of short-term borrowings. Accordingly, the Company has reflected these short-term borrowings as long-term debt at December 31, 1998.
Various credit agreements contain covenants requiring the Company to maintain certain financial ratios. The Company’s ability to pay dividends is restricted upon the failure to maintain such financial ratios. At December 31, 1998, the Company was in compliance with these covenants.
The annual maturities of long-term debt outstanding are as follows as of December 31, 1998:
Year ended Amount 2000 Ps. 78,882 2001 2,407,542 2002 30,766 2003 and thereafter 2,806,563 Ps. 5,323,753
As of December 31, 1998, the Company had uncommitted lines of credit with several banks totaling approximately U.S.$357 million (Ps.3,527,160).
10. SENIORITY PREMIUM AND SAVINGS PLAN
Seniority premium cost and other employee retirement benefits for employees are determined by independent actuaries and are principally based on the employees’ years of service, age, and salaries. The Company has established trust funds to meet these obligations.
The components of the net seniority premium cost for the years ended December 31, consist of the following:
1998 1997
Service cost Ps. 1,719 Ps. 1,292 Interest cost 454 457 Expected return on plan assets (616) (688) Reorganization adjustment (811) - Net amortization of gain (107) (373) Net cost Ps. 639 Ps. 688
16 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
As of December 31, the status of the plan is as follows:
1998 1997 Actuarial present value of benefit obligations: Vested benefit obligation Ps. (7,480) Ps. (4,824) Non-vested benefit obligation (436) (3,508) Accumulated benefit obligations (7,916) (8,332) Excess of projected benefit obligation over accumulated benefit obligation (3,297) (3,034) Projected benefit obligation (11,213) (11,366) Plan assets at fair value 12,428 13,817 Plan assets in excess of projected benefit obligations 1,215 2,451 Unrecognized amounts to be amortized over 17 years: Unrecognized cumulative net gain (2,188) (3,667) Unrecognized net transition obligation (37) (248) Unrecognized additional liability (457) - Unrecognized prior service cost (211) (139) Seniority premium liability Ps. (1,678) Ps. (1,603)
Significant assumptions (weighted average rates, net of expected inflation) used in determining the seniority premium cost were as follows Year ended December 31, 1998 1997
Discount rate 4.0% 4.0% Rate of increase in future compensation levels 2.0% 2.0% Expected long-term rate of return on plan assets 5.0% 5.0% Inflation rate 8.0% 8.0%
In the United States, the Company has a savings and investment plan that incorporates voluntary employee 401(K) contributions with Company contributions. For the years ended December 31, 1998 and 1997, total expenses related to this plan were U.S.$1,989 (Ps.19,651) and U.S.$1,793 (Ps.17,715), respectively.
11. COMMITMENTS AND CONTINGENCIES
The Mexican tax authorities have disallowed certain deductions for income tax purposes, the effect of which on prior years’ income tax amounted to Ps.1,037 plus the related surcharges and penalties. The Company is also involved in a number of claims arising in the ordinary course of business in the United States which have not been finally adjudicated. The resolution of these matters is not expected to have a material adverse effect on the Company’s consolidated financial position or results of operations.
The Company entered into sale-leaseback agreements for various production equipment located in its United States plants. The Company has a purchase option at fair market value at the expiration of the leases and an early purchase option, which permits the Company to acquire the equipment at fair market value at approximately 75% of the lease term. These agreements are accounted for as operating leases.
Rental expense was approximately U.S. $27.7 million (Ps.273,636) and U.S. $25.0 million (Ps.245,303) for the years ended December 31, 1998 and 1997, respectively.
17 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
As of December 31, 1998, the Company is leasing certain of its equipment under long-term operating lease agreements expiring through 2011. Future minimum lease payments under such leases amount to approximately U.S. $156.3 million (Ps.1,543,878), as follows: U.S. dollars (thousands)
Year Facilities Equipment Total
1999 U.S.$ 5,609 U.S.$ 22,600 U.S.$ 28,209 2000 4,286 22,487 26,773 2001 3,771 15,003 18,774 2002 2,704 13,178 15,882 2003 2,107 12,235 14,342 2004 and thereafter 6,968 45,315 52,283 U.S.$ 25,445 U.S.$ 130,818 U.S.$ 156,263 Ps. 251,397 Ps. 1,292,482 Ps. 1,543,879
As of December 31, 1998, the Company has various outstanding commitments in the United States to purchase commodities of approximately U.S.$52.6 million (Ps.519,224), which will be delivered during 1999.
As of December 31, 1998, restricted cash of Ps.4,851 (Ps.83,391 in 1997) includes undisbursed proceeds from the issuance of tax-exempt industrial development revenue bonds in the United States amount to Ps.1,680 (Ps.56,478 in 1997) which are available to fund further development of two plants. At December 31, 1997, restricted cash includes an interest-bearing deposit of Ps.26,913, for claims pursuant to the self-insured workers’ compensation retention program for operations in the United States. In 1998, this restricted cash balance was released.
To minimize the risk created by price fluctuations of corn, wheat and soybean oil, the Company follows a policy of hedging the purchase of a portion of their production requirements through commodity futures contracts. The Company’s open positions for hedging of purchases do not exceed the maximum production requirements for a one-year period. Unrealized gains or losses on open futures contracts are not recognized in the financial statements until the futures contracts are settled. Realized gains or losses are deferred as a component of inventory and recognized as production costs as the inventory is used. Total amortization of deferred losses to cost of sales for the period ended December 31, 1998 was Ps.29,694. Total amortization of deferred gains to cost of sales for the year ended December 31, 1997 was Ps.6,392. The deferred loss included as a component of inventory at December 31, 1998 and 1997 was Ps.51,231 and Ps.28,780, respectively. At December 31, 1998, the Company had open futures in the amount of Ps.45,399. The contracts expire during 1999.
12. STOCKHOLDERS’ EQUITY
A) COMMON STOCK
At the stockholders’ meeting held on April 28, 1998, an issuance of 5,809,656 common shares via a stock dividend was approved as a result of a retained earnings capitalization.
At the stockholders’ meeting held on April 21, 1997, an issuance of 6,840,537 common shares via a stock dividend was approved as a result of a retained earnings capitalization.
As of December 31, 1998, the Company’s outstanding common stock consisted of 353,196,619 shares of Series “B”, with no par value, which can only be retired with stockholders’ approval, and 2,631,681 shares held in Treasury (349,271,363 shares subscribed and paid and 8,441,337 common authorized shares held in Treasury as of December 31, 1997). 18 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
B) EXECUTIVE STOCK PURCHASE PLAN
The Company has established through an irrevocable grantor trust an “Executive Stock Purchase Plan” designating up to 5,422,519 common shares which are reserved for issuance pursuant to this plan, which are subscribed and paid. The shares will be granted to execu- tives, and such executives will have the right to receive dividends during the six year term after joining the plan.
As of December 31, 1998, the Company had granted 2,645,385 Series “B” shares under this plan, 844,250, 821,850, 749,285 and 230,000 shares will fully vested by December 31, 1999, 2001, 2002 and 2003, respectively.
The Company recognizes as an expense, by the straight-line method, the market value of the shares at grant date over the six year period. The amount recognized as expense for the years ended December 31, 1998 and 1997 was Ps.8,305 and Ps.5,160, respectively.
C) RETAINED EARNINGS
In accordance with Mexican law, the legal reserve must be increased by 5 % of annual net profits until it reaches 20 % of the capital stock amount.
A 53.85% tax is payable by the Company if dividends are paid from earnings that have not been subject to Mexican income tax. Additionally, starting 1999 dividends paid to individuals and foreign residents will be subject to a withholding tax of a 7.69% as maximum of the dividend paid.
D) PURCHASE OF COMMON STOCK
At the stockholders’ meeting held on April 21, 1997, an increase of Ps.500,00 to Ps.650,000 in the reserve was approved to allow the Company to repurchase its own shares. The amount of shares repurchased can not exceed the reserve amount or 5% of total equity. As of December 31, 1998, the Company has repurchased 3,700,400 of its own shares for Ps.92,510, the market value at this date.
E) FOREIGN CURRENCY TRANSLATION ADJUSTMENTS
As of December 31, 1998 and 1997, “Foreign currency translation adjustments” consist of the following:
1998 1997 Accumulated effect on translating the opening net investment in foreign subsidiaries Ps. 341,622 Ps. 309,735 Effect from translating income and expense items at the monthly average exchange rates and assets and liabilities at the year-end closing rates 673,554 124,161 Exchange differences arising on foreign currency liabilities accounted for as a hedge of the Company’s net investments in foreign entities (608,922) (83,890) Ps. 406,254 Ps. 350,006
19 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
F) INFLATION EFFECTS
As of December 31, 1998, the majority stockholders’ equity is comprised of the following:
Nominal Restatement Total Common stock Ps. 2,944,805 Ps. 3,517,757 Ps. 6,462,562 Additional paid-in capital 1,279,191 1,100,036 2,379,227 Deficit from restatement - (7,026,024) (7,026,024) Retained earnings from prior years 1,947,113 3,116,453 5,063,566 Net income for the year 378,086 39,199 417,285 Foreign currency translation adjustments 288,023 118,231 406,254 Ps. 6,837,218 Ps. 865,652 Ps. 7,702,870
13. COMPLEMENTARY REVENUE AND SUBSECUENT EVENT
In connection with the Mexican government’s program of providing price supports for corn growers and price controls for tortillas, the company as a corn flour producer received in 1998 and 1997 complemen- tary revenues from the Mexican government based on their related volume of corn flour sales.
For purpose of the complementary revenue payment program, the Mexican government established the “Indifference Price”, which is used by the corn flour producers in determining their cost and this indif- ference price based on international corn prices at the Chicago Board of Trade (CBOT). Corn flour pro- ducers received complementary revenues based on international corn price instead of domestic corn price.
Starting in 1997, the Mexican government periodically increased the tortilla price resulting in a gradual decrease in the amount of complementary revenues received by the Company. On September 18, 1998, the tortilla’s official price was three pesos per kilogram, at which time the complementary revenues received by the Company were practically reduced to zero, except in the state of Chiapas whereby tortilla prices were maintained at Ps.2.60 per kilogram.
As of December 31, 1998, the Mexican government adopted a new regulation that completely eliminated tortilla related subsidies and price controls relating to tortillas and corn flour. Consequently, January 1, 1999 was the end of the regulation of tortilla and corn flour industry in Mexico; and such, complementary revenues will no longer be received by the Company.
For the years ended December 31, 1998 and 1997, net sales include complementary revenues of Ps.620,423 and Ps.1,724,004, respectively.
14. OTHER EXPENSE, NET
Other expense, net is comprised of the following: Year ended December 31,
1998 1997
Reorganization expenses Ps. (188,420) Ps (64,876) Amortization of excess of cost over book value and other (53,174) (54,685) Other (829) 10,928 Ps (242,423) Ps (108,633)
20 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
15. INCOME TAXES, ASSET TAX AND EMPLOYEES’ STATUTORY PROFIT SHARING
A) INCOME TAX AND ASSET TAX
Gruma files a consolidated income tax return for Mexican income tax purposes, consolidating taxable income and losses of Gruma and its controlled Mexican subsidiaries. Filing a consolidated tax return had the effect of reducing income tax expense for the years ended December 31, 1998 and 1997 by Ps.393,759 and Ps.170,373, respectively, as compared to filing a tax return on an unconsolidated-basis. Effective January 1, 1999, new tax regulations limit the income tax consolidation to 60% of the ownership interest of controlled Mexican subsidiaries.
In accordance with the applicable tax law, Mexican corporations must pay the higher of either income tax or asset tax (1.8%). Asset tax is determined on the average value of substantially all of the Company’s Mexican assets less certain liabilities. Payments of asset tax are recoverable against the excess of income tax over asset tax of the three prior years and the ten subsequent years. For the years ended December 31, 1998 and 1997, asset tax amounted to Ps.69,077 and Ps.74,763, respectively, and is included as a component of income tax expense for those years.
B) RECONCILIATION OF FINANCIAL AND TAXABLE INCOME
In Mexico, differences arise between financial and taxable income, causing the statutory income tax rate (34%) to be different from the effective income tax rate. The most important differences are: (a) permanent differences, mainly attributable to inflation effects, and (b) temporary differences between financial and taxable income, primarily due to the increase in corn inventory levels (purchases of inventories are deductible when purchased), contributions made to research and development trust funds and prior years tax loss amortization.
For the years ended December 31, 1998 and 1997, the Company’s subsidiaries recognized deferred income taxes and employees’ statutory profit sharing relating to non-recurring temporary differences arising between financial and taxable income in the amounts of Ps.(238,984) and Ps.6,246, respectively, which consist of the following:
1998 1997 Differences between financial and taxable basis of inventory Ps. 25,861 Ps 9,862 Tax deduction of contributions made to research and development trust funds 4,844 5,221 Differences between financial and taxable revenues and other provisions (34,199) (78,231) Differences between financial and taxable revenues of subsidiaries located in the United States (235,490) 69,394 Ps. (238,984) Ps. 6,246
At December 31, 1998, the Company’s Mexican subsidiaries had additional recurring temporary differences with an indefinite future reversal, whose effect on income tax and employees’ statutory profit sharing amounts to approximately Ps.162,761. Under Mexican GAAP, the deferred tax effects of these types of items are not recognized.
21 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
C) TAX LOSS CARRYFORWARDS AND RECOVERABLE ASSET TAX
At December 31, 1998, the Company has tax loss carryforwards in Mexico of approximately Ps.732,846 available to offset its taxable income in subsequent years, as shown below:
Expiration year Amount
2004 Ps. 308,813 2005 424,033 Ps. 732,846
At December 31, 1998, the asset tax available in Mexico to offset the excess of income tax over asset tax in future years is as follows:
Expiration year Amount 2001 Ps. 23,715 2002 26,489 2003 21,440 2004 26,488 2005 19,295 2006 21,343 2007 79,616 2008 57,624 Ps. 276,010 D) EMPLOYEES’ STATUTORY PROFIT SHARING
In Mexico, employees’ statutory profit sharing is determined for each subsidiary (not on consoli- dated basis) on a basis similar to income tax, except that the employee’s statutory profit sharing does not consider inflation effects (inflationary component), the depreciation expense is based on the his- torical cost, and the foreign exchange gain or loss is recognized when a monetary asset or liability is contractually due.
16. FOREIGN CURRENCY
A) EXCHANGE DIFFERENCES
For the years ended December 31, 1998, and 1997, the effects of exchange rate fluctuations on the Company’s monetary assets and liabilities amounted to Ps.(726,736) and Ps.(68,149), respectively, which were recognized as follows: 1998 1997
Exchange differences arising from foreign currency liabilities accounted for as a hedge of the Company’s net investments in foreign subsidiaries were recorded directly to stockholders’ equity as an effect of foreign currency translation adjustments Ps. (608,922) Ps. (83,890) Exchange differences arising from foreign currency transactions charged to income for the year (59,826) 15,741 Exchange differences arising from foreign currency transactions charged to property, plant and equipment (57,988) -
Ps. (726,736) Ps. (68,149) 22 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
B) FOREIGN CURRENCY POSITION
As of December 31, 1998 and 1997, monetary assets and liabilities held or payable in U.S. dollars are:
By companies located in Mexico: Thousands of U.S. dollars 1998 1997 Assets U.S.$ 12,926 U.S.$ 111,114 Liabilities (483,498) (429,631) U.S.$ (470,572) U.S.$ (318,517)
By foreign companies: Thousands of U.S. dollars
1998 1997 Assets U.S.$ 95,946 U.S.$ 98,250 Liabilities (185,302) (154,528) U.S.$ (89,356) U.S.$ (56,278)
At December 31, 1998 and 1997, the exchange rates used to translate U.S. dollar assets and liabilities were Ps.9.88 and Ps.8.08, respectively. On February 18, 1998 (date of issuance of these financial state- ments), the exchange rate for the U.S. dollar was Ps.9.90.
Gruma and its Mexican subsidiaries had transactions in U.S. dollars as follows for the years ended December 31:
Thousands of U.S. dollars 1998 1997 Corn purchases and other inventories U.S.$ 66,120 U.S.$ 17,717 Interest expense 17,171 29,856 Equipment purchases 4,916 4,160 Services 427 821 U.S.$ 88,634 U.S.$ 52,554
Fixed assets of foreign origin, which are restated on the basis of the GPCI from the foreign country, are as follows: 1998 1997
Foreign Exchange rate Foreign Exchange rate currency at the end of currency at the end of (thousands) the year (thousands) the year
U.S. dollars 309,677 9.88 309,677 8.08 Swiss francs 13,522 7.17 12,840 5.55 Deutsche marks 35,186 5.92 36,682 4.51 Italian lira 3,689,218 0.0060 3,169,676 0.0046 Czechoslovakia koruna 6,620 0.3290 5,984 0.2335 Japanese yen 127,272 0.0871 8,256 0.0621 Spanish pesetas 712,602 0.0695 1,816 0.0538 Costa Rican colones 21,606,737 0.0364 18,101,952 0.0330
23 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
17. SEGMENT INFORMATION
A summary of information by geographic segments is as follows:
1998 % 1997 % NET SALES: Mexico Ps. 5,541,385 40 Ps. 5,811,276 44 United States 7,228,467 53 6,422,970 49 Central America 1,003,966 7 960,059 7 Ps. 13,773,818 100 Ps. 13,194,305 100
OPERATING INCOME (LOSS): Mexico Ps. 647,799 63 Ps. 602,794 65 United States 406,389 39 342,964 36 Central America (22,625) (2) (4,817) (1) Ps. 1,031,563 100 Ps. 940,941 100
IDENTIFIABLE ASSETS: Mexico Ps. 9,951,144 58 Ps. 10,980,749 66 United Statess 5,788,719 34 4,352,301 26 Central America 1,432,666 8 1,317,981 8 Ps. 17,172,529 100 Ps. 16,651,031 100
DEPRECIATION AND AMORTIZATION: Mexico Ps. 353,863 54 Ps. 370,650 58 United States 229,731 35 239,765 37 Central America 70,287 11 31,813 5 Ps. 653,881 100 Ps. 642,228 100
CAPITAL EXPENDITURES: Mexico Ps. 799,623 48 Ps. 749,379 65 United States 678,019 41 331,140 28 Central America 188,313 11 78,073 7 Ps. 1,665,955 100 Ps. 1,158,592 100
The main subsidiaries of the Company are Grupo Industrial Maseca, S.A. de C.V. and subsidiaries, Gruma Corporation and subsidiaries and Gruma Centro América, S.A. and subsidiaries.
Grupo Industrial Maseca, S.A. de C.V. and subsidiaries is located in Mexico. The summary financial data for this subsidiary, expressed in Mexican pesos is as follows:
Grupo Industrial Maseca S.A. de C.V. and subsidiaries
1998 1997
Net sales Ps. 5,069,169 Ps. 5,428,356 Operating income 794,587 755,037 Identifiable assets 6,169,558 5,900,566
24 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Gruma Corporation is located in the United States. Its summary financial data expressed in U.S. dollars is as follows: Gruma Corporation and Subsidiaries (thousands of U.S. dollars) 1998 1997 Net sales U.S.$ 670,424 U.S.$ 602,540 Operating income 46,501 39,986 Identifiable assets 591,391 440,429
18. FINANCIAL INSTRUMENTS
A) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable, restricted cash, trade accounts payable, bank loans, current portion of long-term debt and accrued liabilities and other payables approximate their fair value, due to their short maturity.
The estimated fair value of the Company’s long-term debt is as follows:
At December 31, 1998 Carrying amount Fair value Liabilities: Eurobonds in U.S. dollars bearing interest at annual rate of 7.625% Ps. 2,470,000 Ps. 2,453,945
At December 31, 1997 Carrying amount Fair value
Liabilities: Eurobonds in U.S. dollars bearing interest at annual rate of 7.625% Ps. 2,454,703 Ps. 2,438,747 Eurobonds in U.S. dollars bearing interest at annual rate of 9.75% 1,227,352 1,231,648
The fair value amounts have been determined by the Company using available market information.
The carrying amount of the remainder of the Company’s long-term debt approximates fair value.
B) CONCENTRATION OF CREDIT RISK
The financial instruments that are subject to a concentration of risk are principally cash and cash equivalents and trade accounts receivable.
The Company invests its excess cash in recognized financial institutions. The concentration of the credit risk with respect to the accounts receivable is limited, as the Company sells its products to a large number of clients which are located in different parts of Mexico, United States and Central America.
25 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
19. RELATED PARTY TRANSACTIONS
As disclosed in Note 5, the Company owns a 9.8% interest in GF Banorte, a Mexican financial institu- tion. As of December 31, 1998, the Company has convertible debentures exchangeable by shares in GF Banorte, S.A. de C.V., amounting to Ps.42,500.
In the normal course of business, the Company obtains long-term financing from the banking and other subsidiaries of this institution at market rates and terms. As of December 31, 1997, the Company had outstanding loans with GF Banorte for Ps.10,464. All loans were paid off in 1998. The interest paid to such subsidiaries of this institution for the year ended December 31, 1997 was Ps.3,446.
During 1998 and 1997, the Company purchased U.S.$43.7 (Ps.431,657) and U.S.$34.4 million (Ps.339,427) of inventory ingredients from ADM, respectively.
20. YEAR 2000 ISSUE
The Year 2000 issue results from software programs and electronic components that are integrated into computer programs, which were developed using two digits, instead of four to define the year. If the Company’s programs with “date” functions are not compatible with the year 2000, the system may recognize “00” as 1900 rather than 2000. This may result in system failures or incorrect calculations which could disrupt operations, including among other things, the temporary inability to process transactions, issue invoices or execute normal business activities.
As part of an operational and administrative modernizing effort for the past two years, the Company has been developing a process for change, which includes an integral technological conversion. The overall modernization project is referred as the “ Maseca 2000 ” project. This project, among other things, includes the implementation of the integral system SAP R/3. The scope of this system includes sales and distribution, production, quality control and administration. Management believes this system, when implemented will eliminate a significant component of the Year 2000 problems. However, the Company, recognizing the need to ensure that its operations are not adversely impacted by this event, launched in June 1998 a company-wide program to become Year 2000 compliant, the program not only covers our information technology, but also for our extended business network. In order to achieve these objectives, teams where created within each subsidiary of the Company, with direct responsibility to develop and implement a plan of action in order to maintain the integrity of the information systems.
The Company is currently in the process of implementing these plans, with the objective of relying on its current information systems, both technological (IT) and non technological (Non-IT), functioning appropriately with respect to the Year 2000 issues. The plan has the following phases: strategic analysis, evaluation and planning, system changes and testing, implementation, relation with its business environment and contingency planning.
The following is the status of the implementation plan for Gruma’s main subsidiaries:
IT Components Non - IT Components Percentage of Percentage of plan completed Deadline plan completed Deadline
Grupo Industrial Maseca, S.A. de C.V. and subsidiaries 95% June 99 50% July 99 Gruma Corporation and subsidiaries 60% July 99 50% May 99 Gruma Centro América, S.A. and subsidiaries 20% October 99 15% October 99 Productos y Distribuidora Azteca, S.A de C.V. and subsidiaries 95% June 99 50% July 99 Desarrollo Industrial y Tecnológico, S.A. de C.V. and subsidiaries 10% November 99 10% August 99 Molinera de México S.A. de C.V. and subsidiaries 10% November 99 50% July 99 26 GRUMA, S.A. DE C.V. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
In the event the automated system were to fail, the Company is maintaining current the documentation for manual operating procedures. If needed, the Company has developed a methodology for communication and training for this contingency plan.
As of December 31, 1998, the total cost of the project was U.S.$11.9 (Ps.118,279).
As a result of the above, Management believes that the effects of the year 2000 issue on the Company’s systems, equipment and processes will not significantly affect the operations of the Company.
In addition, the Company has initiated a formal communications process with clients and suppliers (both actual and potential) to determinate the extent to which the Company is vulnerable if such external agents fail to remedy their own year 2000 issue. The satisfactory solution of the year 2000 issue is dependent upon, among other factors, the proper execution of the Company’s implementation plan and SAP R/3 conversion, as well as the Company’s and its external agents timely detection and correction of all significant year 2000 implications before the beginning of the next century.
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