UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 1999
Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from ____ to ____
Commission file number 1-12
THE QUAKER OATS COMPANY
(Exact name of registrant as specified in its charter)
New Jersey 36-1655315
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Quaker Tower P.O. Box 049001 Chicago, Illinois 60604-9001
(Address of principal executive office) (Zip Code)
(312) 222-7111
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file for such reports), and (2)
has been subject to such filing requirements for the past 90 days.
YES XX NO
The number of shares of Common Stock, $5.00 par value, outstanding as
of the close of business on June 30, 1999 was 133,791,009.
THE QUAKER OATS COMPANY AND SUBSIDIARIES
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Consolidated Statements of Income
and Reinvested Earnings for the Six and Three Months
Ended June 30, 1999 and 1998 3-4
Condensed Consolidated Balance Sheets as of
June 30, 1999 and December 31, 1998 5
Condensed Consolidated Statements of Cash
Flows for the Six Months Ended
June 30, 1999 and 1998 6
Net Sales and Operating Income by Segment for the
Six and Three Months Ended June 30, 1999 and 1998 7-8
Notes to the Condensed Consolidated Financial Statements 9-13
Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations 14-21
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 22
Item 4 - Submission of Matters to a Vote of Security Holders 22-23
Item 6 - Exhibits and Reports on Form 8-K 23
SIGNATURES 24
EXHIBIT INDEX 25
<2>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND REINVESTED EARNINGS (UNAUDITED)
Six Months Ended
Dollars in Millions (Except Per Share Data) June 30,
1999 1998
Net sales $ 2,392.1 $ 2,474.0
Cost of goods sold 1,082.4 1,228.7
Gross profit 1,309.7 1,245.3
Selling, general and administrative expenses 942.6 951.4
Gain on divestiture and restructuring and
asset impairment charges (8.4) 87.7
Interest expense 32.5 35.8
Interest income (5.3) (4.0)
Foreign exchange loss - net 15.6 8.9
Income before income taxes 332.7 165.5
Provision for income taxes 74.0 62.0
Net Income 258.7 103.5
Preferred dividends - net of tax 2.2 1.7
Net Income Available for Common $ 256.5 $ 101.8
Per Common Share:
Net income $ 1.90 $ 0.74
Net income - assuming dilution $ 1.83 $ 0.72
Dividends declared $ 0.57 $ 0.57
Average Number of Common Shares Outstanding
(in thousands) 134,960 138,036
Reinvested Earnings:
Balance - beginning of period $ 555.8 $ 431.0
Net income 258.7 103.5
Dividends (78.7) (80.3)
Balance - end of period $ 735.8 $ 454.2
See accompanying notes to the condensed consolidated financial statements.
<3>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND REINVESTED EARNINGS (UNAUDITED)
Three Months Ended
Dollars in Millions (Except Per Share Data) June 30,
1999 1998
Net sales $ 1,317.5 $ 1,381.7
Cost of goods sold 594.1 676.5
Gross profit 723.4 705.2
Selling, general and administrative expenses 498.5 516.4
Restructuring and asset impairment charges -- 78.6
Interest expense 16.1 17.6
Interest income (2.8) (1.8)
Foreign exchange loss - net 1.3 4.7
Income before income taxes 210.3 89.7
Provision for income taxes 38.3 33.2
Net Income 172.0 56.5
Preferred dividends - net of tax 1.1 0.9
Net Income Available for Common $ 170.9 $ 55.6
Per Common Share:
Net income $ 1.27 $ 0.41
Net income - assuming dilution $ 1.22 $ 0.40
Dividends declared $ 0.285 $ 0.285
Average Number of Common Shares Outstanding
(in thousands) 134,642 137,577
Reinvested Earnings:
Balance - beginning of period $ 603.2 $ 438.0
Net income 172.0 56.5
Dividends (39.4) (40.3)
Balance - end of period $ 735.8 $ 454.2
See accompanying notes to the condensed consolidated financial statements.
<4>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
Dollars in Millions 1999 1998
Assets
Current Assets:
Cash and cash equivalents $ 190.3 $ 326.6
Marketable securities 153.1 27.5
Trade accounts receivable - net of allowances 377.8 283.4
Inventories:
Finished goods 214.1 189.1
Grains and raw materials 46.4 48.4
Packaging materials and supplies 27.0 23.9
Total inventories 287.5 261.4
Other current assets 197.8 216.1
Total Current Assets 1,206.5 1,115.0
Property, plant and equipment 1,792.5 1,818.8
Less: accumulated depreciation 740.3 748.6
Property - net 1,052.2 1,070.2
Intangible assets - net of amortization 241.2 245.7
Other assets 68.7 79.4
Total Assets $ 2,568.6 $ 2,510.3
Liabilities and Shareholders' Equity
Current Liabilities:
Short-term debt $ 30.1 $ 41.3
Current portion of long-term debt 120.6 95.2
Trade accounts payable 219.4 168.4
Other current liabilities 701.7 704.2
Total Current Liabilities 1,071.8 1,009.1
Long-term debt 748.7 795.1
Other liabilities 539.3 533.4
Preferred Stock, Series B, no par value, authorized
1,750,000 shares; issued 1,282,051 of
$5.46 cumulative convertible shares
(liquidating preference of $78 per share) 100.0 100.0
Deferred compensation (43.5) (48.4)
Treasury Preferred Stock, at cost, 335,269 shares
and 302,969 shares, respectively (34.4) (29.9)
Common Shareholders' Equity:
Common stock, $5 par value, authorized 400
million shares; issued 167,978,792 shares 840.0 840.0
Additional paid-in capital 94.8 78.9
Reinvested earnings 735.8 555.8
Cumulative translation adjustment (101.1) (80.5)
Unrealized gain on marketable securities 3.0 0.4
Deferred compensation (68.5) (67.6)
Treasury common stock, at cost, 34,187,783
shares and 32,656,284 shares, respectively (1,317.3) (1,176.0)
Total Common Shareholders' Equity 186.7 151.0
Total Liabilities and Shareholders' Equity $ 2,568.6 $ 2,510.3
See accompanying notes to the condensed consolidated financial statements.
<5>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months
Dollars in Millions Ended June 30,
1999 1998
Cash Flows from Operating Activities:
Net income $ 258.7 $ 103.5
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 60.4 67.7
Deferred income taxes 3.2 (22.1)
Gain on divestiture - net of tax of $1.7 (3.4) --
Restructuring charges (3.3) 24.7
Asset impairment losses -- 63.0
Loss on disposition of property, plant and equipment 5.4 2.1
Increase in trade accounts receivable (108.6) (99.4)
Increase in inventories (36.1) (28.1)
Decrease in other current assets 16.1 17.1
Increase in trade accounts payable 55.4 74.8
Increase in other current liabilities 12.7 59.6
Change in deferred compensation 4.0 5.1
Other items 50.8 4.8
Net Cash Provided by Operating Activities 315.3 272.8
Cash Flows from Investing Activities:
Capital gains tax recovery -- 240.0
Business divestitures 14.3 73.2
Purchase of marketable securities (123.0) (111.2)
Additions to property, plant and equipment (76.5) (84.6)
Proceeds on sale of property, plant and equipment 4.5 3.5
Net Cash (Used in) Provided by Investing Activities (180.7) 120.9
Cash Flows from Financing Activities:
Cash dividends (78.7) (80.3)
Change in short-term debt (8.5) (21.1)
Proceeds from long-term debt 0.6 0.8
Reduction of long-term debt (21.4) (73.0)
Issuance of common treasury stock 55.6 68.0
Repurchases of common stock (209.5) (250.2)
Repurchases of preferred stock (4.5) (3.3)
Net Cash Used in Financing Activities (266.4) (359.1)
Effect of Exchange Rate Changes on Cash and Cash Equivalents (4.5) 10.0
Net (Decrease) Increase in Cash and Cash Equivalents (136.3) 44.6
Cash and Cash Equivalents - Beginning of Period 326.6 84.2
Cash and Cash Equivalents - End of Period $ 190.3 $ 128.8
See accompanying notes to the condensed consolidated financial statements.
<6>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NET SALES AND OPERATING INCOME BY SEGMENT
(UNAUDITED)
Net Sales (a) Operating Income (Loss)(b)
Six Months Six Months
Dollars in Millions Ended June 30, Ended June 30,
1999 1998 1999 1998
Foods:
U.S. and Canadian $ 1,140.1 $ 1,103.8 $ 184.7 $ 153.2
Latin American 150.7 187.9 12.0 13.8
Other (c) 103.0 92.6 14.1 (2.6)
Total Foods 1,393.8 1,384.3 210.8 164.4
Beverages:
U.S. and Canadian 812.8 715.1 164.0 137.3
Latin American 118.1 143.1 10.1 14.0
Other (c) 60.7 59.1 (2.8) 0.3
Total Beverages 991.6 917.3 171.3 151.6
Total Ongoing Businesses 2,385.4 2,301.6 382.1 316.0
Divested Businesses (d) 6.7 172.4 -- (4.2)
Total Sales/Operating Income $ 2,392.1 $ 2,474.0 $ 382.1 $ 311.8
Less: Gain on divestiture and
restructuring and asset
impairment charges (e) (f) (8.4) 87.7
General corporate expenses 15.0 17.9
Interest expense - net 27.2 31.8
Foreign exchange loss - net 15.6 8.9
Income before income taxes $ 332.7 $ 165.5
(a) Intersegment revenue is not material.
(b) Business segment operating results exclude gain on divestiture,
restructuring and asset impairment charges and certain other expenses not
allocated to business segments such as income taxes, general corporate expenses
and financing costs.
(c) Other includes European and Asia/Pacific businesses.
(d) 1999 includes net sales and operating results (through the divestiture
date) for the Brazilian pasta business. 1998 includes six months of net sales
and operating results for the Ardmore Farms, Continental Coffee, Nile Spice,
Liqui-Dri and Brazilian pasta businesses.
(e) 1999 includes a pretax gain of $5.1 million for the sale of the Brazilian
pasta business and pretax income of $3.3 million to reverse certain prior
divestiture and restructuring reserves.
(f) 1998 includes pretax restructuring charges of $24.7 million for
organization alignment and non-cash, pretax asset impairment losses of $63.0
million related to the divested Continental Coffee and Brazilian pasta
businesses.
<7>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NET SALES AND OPERATING INCOME BY SEGMENT
(UNAUDITED)
Net Sales (a) Operating Income (b)
Three Months Three Months
Dollars in Millions Ended June 30, Ended June 30,
1999 1998 1999 1998
Foods:
U.S. and Canadian $ 534.2 $ 530.9 $ 71.9 $ 64.4
Latin American 77.5 92.7 6.2 5.2
Other (c) 50.9 45.7 8.2 --
Total Foods 662.6 669.3 86.3 69.6
Beverages:
U.S. and Canadian 545.2 509.4 135.7 120.3
Latin American 65.9 70.5 7.6 6.4
Other (c) 43.8 42.6 0.2 1.7
Total Beverages 654.9 622.5 143.5 128.4
Total Ongoing Businesses 1,317.5 1,291.8 229.8 198.0
Divested Businesses (d) -- 89.9 -- 0.9
Total Sales/Operating Income $ 1,317.5 $ 1,381.7 $ 229.8 $ 198.9
Less: Restructuring and asset
impairment charges (e) -- 78.6
General corporate expenses 4.9 10.1
Interest expense - net 13.3 15.8
Foreign exchange loss - net 1.3 4.7
Income before income taxes $ 210.3 $ 89.7
(a) Intersegment revenue is not material.
(b) Business segment operating results exclude restructuring and asset
impairment charges and certain other expenses not allocated to business
segments such as income taxes, general corporate expenses and financing costs.
(c) Other includes European and Asia/Pacific businesses.
(d) 1998 includes three months of net sales and operating results for the
Ardmore Farms, Continental Coffee, Nile Spice, Liqui-Dri and Brazilian pasta
businesses.
(e) 1998 includes pretax restructuring charges of $15.6 million for
organization alignment and non-cash, pretax asset impairment losses of $63.0
million related to the divested Continental Coffee and Brazilian pasta
businesses.
<8>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1999
Note 1 - Basis of Presentation
The condensed consolidated financial statements include The Quaker Oats Company
and its subsidiaries (the Company). The condensed consolidated statements of
income and reinvested earnings for the six and three months ended June 30, 1999
and 1998, the condensed consolidated balance sheet as of June 30, 1999, and the
condensed consolidated statements of cash flows for the six months ended June
30, 1999 and 1998, have been prepared by the Company without audit. In the
opinion of management, these financial statements include all adjustments
necessary to present fairly the financial position, results of operations and
cash flows as of June 30, 1999, and for all periods presented. All adjustments
made have been of a normal and recurring nature. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles (GAAP) have been
condensed or omitted. The Company believes that the disclosures included are
adequate and provide a fair presentation of interim period results. Interim
financial statements are not necessarily indicative of the financial position
or operating results for an entire year. It is suggested that these interim
financial statements be read in conjunction with the audited financial
statements and the notes thereto included in the Company's report to
shareholders for the year ended December 31, 1998.
Certain previously reported amounts have been reclassified to conform to the
current presentation.
Note 2 - Litigation
The Company is a party to a number of lawsuits and claims, which it is
vigorously defending. Such matters arise out of the normal course of business
and relate to the Company's past acquisition activity and other issues.
Certain of these actions seek damages in large amounts. While the results of
litigation cannot be predicted with certainty, management believes that the
final outcome of such litigation will not have a material adverse effect on the
Company's consolidated financial position or results of operations. Changes in
assumptions, as well as actual experience, could cause the estimates made by
management to change.
Note 3 - Restructuring Charges and Tax Adjustments
During the six months ended June 30, 1999 (current year), the Company recorded
pretax adjustments of $3.3 million to reverse certain prior divestiture and
restructuring reserves. These adjustments, recorded in the first quarter of
1999, were primarily due to higher-than-anticipated proceeds on the sale of a
closed facility. During the three and six months ended June 30, 1998, the
Company recorded pretax restructuring charges of $15.6 million and $24.7
million, respectively, for organization alignment. The Company's remaining
restructuring actions are proceeding as planned, and the related reserve
balances are considered adequate to cover committed restructuring actions. The
Company continues to review its business strategies for other cost-reduction
opportunities, some of which could result in future charges.
In 1999, the Company also adjusted its tax accruals and tax assets to reflect
developments and information received during the current year. The net effect
of these adjustments was to reduce the current year tax provision by $37.7
million for the three months ended June 30, 1999, and $46.1 million for the
current year.
<9>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1999
Note 4 - Divestitures and Asset Impairment Charges
On March 1, 1999, the Company completed the sale of its Brazilian pasta
business for $14.3 million and realized a pretax gain of $5.1 million. During
the first quarter of 1998, the Company received $240.0 million from the
recovery of income taxes paid on previous capital gains and cash proceeds of
$73.2 million from the December 1997 divestiture of certain food service
businesses.
During the six months ended June 30, 1998, the Company recorded $63.0 million
for asset impairment losses related to the divested Continental Coffee and
Brazilian pasta businesses.
Note 5 - Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
Note 6 - Marketable Securities
During 1999, the Company made investments in marketable securities. These
marketable securities are available for sale and consist of investments in
mutual funds and preferred stock. These investments are expected to be held
less than twelve months and are classified as marketable securities in the
consolidated balance sheet. In 1999, the Company recorded an unrealized gain
of $2.6 million on its investments in marketable securities to adjust the
carrying value of these investments to fair value. The unrealized gain is
classified as a separate component of common shareholders' equity and is
included in comprehensive income.
Note 7 - Comprehensive Income
Total comprehensive income for the three months ended June 30, 1999 and 1998,
was $169.3 million and $53.0 million, respectively. For the six months ended
June 30, 1999 and 1998, total comprehensive income was $240.7 million and
$108.4 million, respectively. Total comprehensive income for the Company
includes net income, foreign currency translation adjustments and unrealized
gains on investments.
Note 8 - Current and Pending Accounting Changes
In January 1998, Statement of Position (SOP) No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use," was issued.
This SOP provides guidance on the accounting for computer software costs. In
April 1998, SOP No. 98-5, "Reporting on the Costs of Start-Up Activities," was
issued. This SOP provides guidance on accounting for the cost of start-up
activities. The Company's adoption of these new Statements in January 1999 did
not materially affect the Company's financial statements.
<10>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1999
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Statement establishes accounting and
reporting standards requiring that all derivative instruments (including
certain derivative instruments imbedded in other contracts) be recorded in the
balance sheet as either an asset or a liability measured at its fair value.
The Statement requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. The accounting provisions for qualifying hedges allow a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that the Company must formally document, designate, and
assess the effectiveness of transactions that qualify for hedge accounting.
The Company is not required to adopt this Statement until January 2001. The
Company has not determined its method or timing of adopting this Statement or
the impact on its financial statements. When adopted, this Statement could
increase volatility in reported earnings and other comprehensive income of the
Company.
Note 9 - Derivative Financial and Commodity Instruments
The Company actively monitors its exposure to commodity price, foreign currency
exchange rate and interest rate risks and uses derivative financial and
commodity instruments to manage the impact of certain risks. The Company's
policy is to use derivatives only for purposes of managing risks associated
with underlying exposures. The Company does not trade or use instruments with
the objective of earning financial gains on the commodity price, exchange rate
or interest rate fluctuations alone, nor does it utilize instruments where
there are not known or anticipated underlying exposures. The Company is
currently evaluating using derivative financial instruments that may result in
short-term gains or losses and increased earnings volatility. Complex
instruments involving leverage or multipliers are not used. Management believes
that its use of these instruments to manage risk is in the Company's best
interest.
Instruments used as hedges must be effective at reducing the risks associated
with the underlying exposure and must be designated as a hedge at the inception
of the contract. Accordingly, changes in the market value of the instruments
must have a high degree of inverse correlation with changes in market values or
cash flows of the underlying hedged item.
Summarized below are the specific accounting policies by market risk category.
Commodity Price Risk
The Company uses commodity futures and options to manage price exposures on
commodity inventories or anticipated purchases of commodities. The deferral
method is used to account for those instruments that effectively hedge the
Company's price exposures. For hedges of anticipated transactions, the
significant characteristics and terms of the anticipated transaction must be
identified, and the transaction must be probable of occurring to qualify for
deferral method accounting. Under the deferral method, gains and losses on
derivative instruments are deferred in the condensed consolidated balance
sheets as a component of other current assets (if a loss) or other current
liabilities (if a gain) until the underlying inventory being hedged is sold.
As the hedged inventory is sold, the deferred gains and losses are recognized
in the condensed consolidated statements of income as a component of cost of
goods sold. Derivative instruments that do not meet the above criteria
required for deferral treatment are accounted for under the fair value method
with gains and losses recognized currently in the condensed consolidated
statements of income as a component of cost of goods sold.
<11>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1999
Foreign Currency Exchange Rate Risk
The Company uses forward contracts, purchased options and currency swap
agreements to manage foreign currency exchange rate risk related to projected
operating income from foreign operations and net investments in foreign
subsidiaries. The fair value method is used to account for these instruments.
Under the fair value method, the instruments are carried at fair value in the
condensed consolidated balance sheets as a component of other current assets
(deferred expense) or other current liabilities (deferred income). Changes in
the fair value of derivative instruments which are used to manage exchange rate
risk in foreign-currency denominated operating income and net investments in
highly inflationary economies are recognized in the condensed consolidated
statements of income as foreign exchange loss or gain. Changes in the fair
value of such instruments used to manage exchange rate risk on net investments
in economies that are not highly inflationary are recognized in the condensed
consolidated balance sheets as a component of the cumulative translation
adjustment in common shareholders' equity and are included in comprehensive
income. To the extent an instrument is no longer effective as a hedge of a net
investment due to a change in the underlying exposure, gains and losses are
recognized currently in the condensed consolidated statements of income as
foreign exchange loss or gain.
Interest Rate Risk
The Company has used interest rate swap agreements to reduce its exposure to
changes in interest rates and to balance the mix of its fixed and floating rate
debt. Currently, there are no interest swap agreements outstanding. The
settlement costs of terminated swap agreements are reported in the condensed
consolidated balance sheets as a component of other assets and are being
amortized over the life of the original swap agreements. The amortization of
the settlement amounts is reported in the condensed consolidated statements of
income as a component of interest expense.
Note 10 - Share Repurchases
During 1999, the Company repurchased 3.2 million shares of its outstanding
common stock for $200.1 million. Of the total shares repurchased, 2.2 million
shares were repurchased during the current quarter for $146.4 million. As of
June 30, 1999, the Company repurchased $464.9 million under the $1 billion
repurchase program announced in March 1998.
<12>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1999
Note 11 - Earnings Per Share
Reconciliations of basic earnings per share (EPS) to diluted EPS were as
follows:
Dollars in Millions
(Except Per Share Data) Six Months Ended June 30,
1999 1998
Income Shares Income Shares
Net income $ 258.7 $ 103.5
Less: Preferred dividends - net of tax 2.2 1.7
Net income available for common $ 256.5 134,960 $ 101.8 138,036
Net income per common share $ 1.90 $ 0.74
Net income available for common $ 256.5 134,960 $ 101.8 138,036
Effect of dilutive securities:
Stock options -- 3,492 -- 3,661
Non-vested awards -- 229 -- 98
ESOP Convertible Preferred Stock 1.0 2,077 1.4 2,214
$ 257.5 140,758 $ 103.2 144,009
Net income per common share-
assuming dilution $ 1.83 $ 0.72
The decrease in average common shares outstanding at June 30, 1999, compared to
June 30, 1998, reflects the continuation of the Company's share repurchase
program, partly offset by the exercise of employee stock options.
As of June 30, 1999 and 1998, certain stock options were excluded from the
computation of diluted EPS because the exercise prices were higher than the
average market price.
<13>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Six Months Ended June 30, 1999 Compared with
Six Months Ended June 30, 1998
Consolidated net sales for the six months ended June 30, 1999 (current year)
decreased 3 percent from the six months ended June 30, 1998 (prior year), due
to the absence of divested businesses. Excluding divested businesses, sales
increased 4 percent from the prior year, led by 14 percent growth in the U.S.
and Canadian Gatorade business and 3 percent growth in the U.S. and Canadian
Foods business, partly offset by declines in the Latin American business.
Price changes did not significantly affect the comparison of current and prior
year net sales. Weaker exchange rates, mainly in Latin America, negatively
affected sales.
The consolidated gross profit margin increased to 54.8 percent in the current
year from 50.3 percent in the prior year. Approximately one-half of the
expanded gross margin was driven by ongoing businesses, primarily due to lower
commodity and packaging costs and other cost-reduction efforts. The remaining
margin improvement resulted from the divestiture of lower-margin businesses in
1998.
Selling, general and administrative (SG&A) expenses decreased $8.8 million, or
1 percent, due to the absence of divested businesses. For ongoing businesses,
SG&A expenses increased $27.6 million, or 3 percent, driven by a 7 percent
increase in advertising and merchandising (A&M) spending. Partly offsetting
this increase, other SG&A expenses decreased as a result of previous
restructuring actions and cost-reduction programs.
Business segment operating income increased 23 percent to $382.1 million in the
current year from $311.8 million in the prior year, primarily driven by sales
growth and lower supply chain costs, resulting in increased operating margins
in both the U.S. and Canadian Gatorade and Foods businesses.
Net financing costs (net interest expense and foreign exchange losses)
increased $2.1 million in the current year, reflecting higher foreign exchange
costs. Brazilian foreign exchange losses increased $11.0 million and were
substantially offset by lower interest expense as a result of lower debt
levels.
The current year consolidated operating results include a $5.1 million pretax
gain on divestiture of the Brazilian pasta business and $3.3 million in pretax
adjustments to reverse prior divestiture and restructuring reserves. The
adjustments were primarily due to higher-than-anticipated proceeds on the sale
of a closed facility. The prior year consolidated operating results include
restructuring charges of $24.7 million for organization alignment and $63.0
million for asset impairment losses related to the divested Continental Coffee
and Brazilian pasta businesses. The Company's remaining restructuring actions
are proceeding as planned; the related reserve balances are considered
adequate to cover committed restructuring actions. The Company continues to
review its business strategies for other cost-reduction opportunities, some of
which could result in future charges.
<14>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Adjustments also were made to reduce previously recorded tax accruals and tax
assets to reflect developments and information received during the current
year. The net effect of these adjustments was to reduce the tax provision by
$46.1 million for the current year. Excluding these tax adjustments and the
tax effects of the gain on divestiture, restructuring and asset impairment
charges, the Company's effective tax rate in the current year was 36.1 percent
versus 37.0 percent in the prior year. The decrease in the effective tax rate
was primarily due to lower effective state tax rates.
Operating Segment Results
Foods
U.S. and Canadian Foods - Volume increased nearly 1 percent and sales increased
3 percent, led by growth in hot cereals. The sales increase in hot cereals
reflects the impact of advertising and merchandising programs, new product
introductions and favorable winter weather compared to the prior year. Sales
also increased in ready-to-eat boxed cereals, grain-based snack bars, corn
goods and many of the Company's Canadian Foods lines, partly offset by sales
declines in flavored rice and pasta, rice cakes, bagged ready-to-eat cereals,
syrups and mixes. U.S. and Canadian Foods operating income increased 21
percent due to sales growth, lower supply chain costs and a favorable product
mix, partly offset by increases in A&M spending.
Latin American Foods - Volume and sales decreased 2 percent and 20 percent,
respectively, primarily driven by the Brazilian recession and currency
devaluation. As a result, operating income decreased $1.8 million. Although
the Brazilian currency has stabilized recently, the recession in the Brazilian
economy continues to affect the current outlook for this business.
Other Foods - Volume and sales increased 8 percent and 11 percent,
respectively, reflecting growth in the European cereals business. Operating
results improved $16.7 million due to the European sales growth and
significantly reduced operating losses in the Asia/Pacific business resulting
from recent restructuring actions.
Beverages
U.S. and Canadian Beverages - Volume and sales grew 17 percent and 14 percent,
respectively. New flavors, such as Gatorade Fierce, and new packaging, such as
the expansion of the single-serve E.D.G.E. sport bottle and 20-ounce wide-mouth
bottle, helped drive growth. In addition, expanded availability, outside
traditional retail channels, drove sales growth. Operating income grew 19
percent to $164.0 million, an increase of $26.7 million from the prior year,
reflecting strong sales growth, partly offset by increased A&M spending.
Latin American Beverages - Volume and sales decreased 12 percent and 17
percent, respectively, primarily driven by the recessions and currency
devaluations in Brazil and Colombia. As a result of these declines and despite
double-digit sales growth in Mexico, operating income decreased $3.9 million.
Although the Brazilian currency has stabilized recently, the recessions in
Brazil and Colombia continue to affect the current outlook for these
businesses.
Other Beverages - Volume and sales increased 3 percent, reflecting sales growth
in both the European and Asia/Pacific businesses. Operating results decreased
$3.1 million, reflecting increased A&M spending.
<15>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Divested
On March 1, 1999, the Company completed the sale of its Brazilian pasta
business for $14.3 million and realized a pretax gain of $5.1 million. Current
year operating results from divested businesses reflect the Brazilian pasta
business through its divestiture date. Prior year operating results from
divested businesses reflect the Ardmore Farms, Continental Coffee, Nile Spice,
Liqui-Dri and Brazilian pasta businesses.
Three Months Ended June 30, 1999 Compared with
Three Months Ended June 30, 1998
Consolidated net sales for the three months ended June 30, 1999 (current year)
decreased 5 percent from the three months ended June 30, 1998 (prior year), due
to the absence of divested businesses. Excluding divested businesses, sales
increased 2 percent from the prior year, led by 7 percent growth in the U.S.
and Canadian Gatorade business. Sales grew 11 percent in the Other Foods
business and 1 percent in the U.S. and Canadian Foods business, which partly
offset declines in the Latin American businesses. Price changes did not
significantly affect the comparison of current and prior year net sales.
Weaker exchange rates, mainly in Latin America, negatively affected sales.
The consolidated gross profit margin increased to 54.9 percent in the current
year from 51.0 percent in the prior year. Approximately one-half of the
expanded gross margin was driven by ongoing businesses, primarily due to lower
commodity and packaging costs and other cost-reduction efforts. The remaining
margin improvement resulted from the divestiture of lower-margin businesses in
1998.
SG&A expenses decreased $17.9 million, or 3 percent, primarily due to the
absence of divested businesses. For ongoing businesses, SG&A expenses
increased $0.4 million. A&M spending increased, but was offset largely by
declines in other SG&A expenses resulting from cost-reduction programs and
previous restructuring actions.
Business segment operating income increased 16 percent to $229.8 million in the
current year from $198.9 million in the prior year. Sales growth and cost
reductions in the U.S. and Canadian Gatorade and worldwide Foods segments drove
the improvement.
Net financing costs (net interest expense and foreign exchange losses)
decreased $5.9 million in the current year, reflecting both lower foreign
exchange costs and interest expense. The decrease in foreign exchange costs
resulted from a lower rate of currency devaluation in Latin American and
Asia/Pacific markets versus the prior year. The decline in interest expense
reflected lower debt levels.
Prior year consolidated operating results include restructuring charges of
$15.6 million for organization alignment and $63.0 million for asset impairment
losses related to the divested Continental Coffee and Brazilian pasta
businesses. The Company's remaining restructuring actions are proceeding as
planned; the related reserve balances are considered adequate to cover
committed restructuring actions.
<16>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
An adjustment was made to reduce previously recorded tax accruals to reflect
developments and information received during the current year. The net effect
of these adjustments was to reduce the current year tax provision by $37.7
million. Excluding these tax adjustments and the tax effects of restructuring
and asset impairment charges, the Company's effective tax rate in the current
year was 36.1 percent versus 36.4 percent in the prior year.
Operating Segment Results
Foods
U.S. and Canadian Foods - Volume decreased 1 percent, while sales increased 1
percent. The sales increase was due primarily to continued hot cereals growth.
New products and advertising drove sales increases in hot cereals, grain-based
snack bars and many of the Company's Canadian food lines. Sales in ready-to-
eat cereals, rice cakes, syrups and mixes declined. Ready-to-eat cereals sales
decreased partly due to lower sales in non-traditional channels, such as mass
merchandisers. U.S. and Canadian operating income increased 12 percent
primarily due to sales growth and lower supply chain costs, partly offset by
increases in A&M spending.
Latin American Foods - Volume increased nearly 1 percent, while sales decreased
16 percent, primarily reflecting the currency devaluation in Brazil. Despite
the weakened Brazilian economy, operating income increased $1.0 million,
reflecting lower A&M spending and effective cost-reduction efforts. Although
the Brazilian currency has stabilized recently, the recession continues to
affect the current outlook for this business.
Other Foods - Volume and sales increased 6 percent and 11 percent,
respectively, primarily due to growth in the European cereals business.
Operating results improved due to the sales growth and significantly reduced
operating losses in the Asia/Pacific business resulting from recent
restructuring actions.
Beverages
U.S. and Canadian Beverages - Volume and sales grew 9 percent and 7 percent,
respectively, despite difficult year-on-year comparisons. In the prior year,
Gatorade volume and sales increased 22 percent and 17 percent, respectively.
New flavors, such as Gatorade Fierce, and new packaging, such as the expansion
of the single-serve E.D.G.E. sport bottle and 20-ounce wide-mouth bottle,
helped drive growth. In addition, expanded availability, outside traditional
retail channels, drove sales growth. Operating income grew 13 percent to
$135.7 million, an increase of $15.4 million from the prior year, reflecting
strong sales growth and supply chain efficiencies, partly offset by increased
A&M spending.
<17>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Latin American Beverages - The recessions and currency devaluations in both
Brazil and Colombia continued to affect current year volume and sales. Volume
decreased 5 percent and sales decreased 7 percent. However, increased sales in
Mexico, cost management efforts, savings from prior-year restructuring actions
and lower A&M spending, allowed the Latin American Beverages segment to
increase operating income by $1.2 million, or 19 percent, over the prior year.
Although the Brazilian currency has stabilized recently, the recessions in
Brazil and Colombia continue to affect the current outlook for these
businesses.
Other Beverages - Volume and sales increased 9 percent and 3 percent,
respectively. The impact of weaker European currencies drove a
disproportionate change between sales and volume. Volume and sales increased
in the Asia/Pacific business, while sales in Europe were nearly even with the
prior year. Operating income decreased $1.5 million as A&M spending increased
to establish the Gatorade brand in China.
Divested
Prior year operating results from divested businesses reflect the Ardmore
Farms, Continental Coffee, Nile Spice and Liqui-Dri businesses divested in
1998, and the Brazilian pasta business divested March 1, 1999.
Liquidity and Capital Resources
Net cash provided by operating activities was $315.3 million, an increase of
$42.5 million from the prior year, reflecting improved operating profitability.
Capital expenditures for the current and prior year were $76.5 million and
$84.6 million, respectively. The rate of capital expenditures is expected to
increase during the remainder of the year as the Company continues to invest in
cost-reduction projects and Gatorade production capacity. The Company expects
that capital expenditures and cash dividends for the remainder of the year will
be financed through cash flow from operating activities.
Cash used in investing activities in the current year includes the Company's
purchase of marketable securities of $123.0 million, partly offset by proceeds
from the sale of the Brazilian pasta business. Cash provided by investing
activities in the prior year includes a $240 million recovery of income taxes
paid on previous capital gains and proceeds of $73.2 million from the December
1997 divestiture of certain food service businesses. These prior year cash
flows were offset partly by the Company's purchase of marketable securities of
$111.2 million.
Financing activities used cash of $266.4 million and $359.1 million in the
current year and prior year, respectively, primarily to repurchase shares, pay
dividends and pay down debt. During the current year, the Company repurchased
3.2 million shares of its outstanding common stock for $200.1 million under the
$1 billion repurchase program announced in March 1998. During the current
year, approximately 1.5 million employee stock options were exercised providing
cash of $51.4 million.
Short-term and long-term debt (total debt) as of June 30, 1999 was $899.4
million, a decrease of $32.2 million from December 31, 1998. Amounts available
under revolving credit facilities and debt and commercial paper ratings were
unchanged during the current quarter.
<18>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Derivative Financial and Commodity Instruments
The Company actively monitors its exposure to commodity price, foreign currency
exchange rate and interest rate risks and uses derivative financial and
commodity instruments to manage the impact of certain risks. The Company's
policy is to use derivatives only for purposes of managing risks associated
with underlying exposures. The Company does not trade or use instruments with
the objective of earning financial gains on the commodity price, exchange rate
or interest rate fluctuations alone, nor does it utilize instruments where
there are not known or anticipated underlying exposures. The Company is
currently evaluating using derivative financial instruments that may result in
short-term gains or losses and increased earnings volatility. Complex
instruments involving leverage or multipliers are not used. Management believes
that its use of these instruments to manage risk is in the Company's best
interest.
The Company has estimated its market risk exposures using sensitivity analyses.
Market risk exposure has been defined as the change in fair value of a
derivative commodity or financial instrument, assuming a hypothetical 10
percent adverse change in market prices or rates. Fair value was determined
using quoted market prices, if available. The results of the sensitivity
analyses as of June 30, 1999, did not differ materially from the amounts
reported as of December 31, 1998. Actual changes in market prices or rates may
differ from hypothetical changes.
Current and Pending Accounting Changes
In January 1998, Statement of Position (SOP) No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use," was issued.
This SOP provides guidance on the accounting for computer software costs. In
April 1998, SOP No. 98-5, "Reporting on the Costs of Start-Up Activities," was
issued. This SOP provides guidance on accounting for the cost of start-up
activities. The Company's adoption of these new Statements in January 1999 did
not materially affect the Company's financial statements.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities." The
Statement establishes accounting and reporting standards requiring that all
derivative instruments (including certain derivative instruments imbedded in
other contracts) be recorded in the balance sheet as either an asset or a
liability measured at its fair value. The Statement requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. The accounting provisions for qualifying
hedges allow a derivative's gains and losses to offset related results of the
hedged item in the income statement, and require that the Company must formally
document, designate and assess the effectiveness of transactions that qualify
for hedge accounting. The Company has not determined its method or timing of
adopting this Statement, but will be required to adopt it by January 2001.
When adopted, this Statement could increase volatility in reported earnings and
other comprehensive income of the Company.
<19>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Year 2000
The Company uses software and other related technologies throughout its
business that will be affected by the date change in year 2000. The three
areas where year 2000 issues may affect the Company include: (1) the computer
systems, both hardware and software; (2) imbedded systems, as in computer chips
in machinery and process controls; and (3) third parties with material
relationships with the Company, such as major service providers, vendors,
suppliers and customers.
To address the year 2000 issues, the Company has developed and is executing a
detailed four-phase comprehensive readiness plan. The first phase of the
readiness plan, the assessment of the Company's internal systems, is complete.
The second phase, the remediation, replacement and testing of computer systems
and imbedded systems, is nearly 100 percent and 97 percent complete,
respectively. The remaining equipment or controls for the imbedded systems are
scheduled for replacement during the remainder of the year. The third phase,
the assessment of the year 2000 readiness plans of the Company's material third
parties, will continue through 1999. All of the Company's major service
providers, vendors, suppliers and customers who are believed to be critical to
the business operations after January 1, 2000, have been contacted to determine
their stage of year 2000 compliance, with approximately 50 percent indicating
that they are fully compliant. The other half are in varying stages of
completion. The fourth phase involves the development of contingency plans to
further mitigate the impact of possible year 2000 disruptions, including
disruptions resulting from non-compliant, material third parties. Although
largely complete, the remaining contingency plans are expected to be completed
by September 30, 1999. These contingency plans may include stockpiling raw and
packaging materials, increasing finished goods inventory levels, securing
alternate suppliers and other appropriate measures.
While the Company's year 2000 readiness plans are nearly complete, the
consequences of non-compliance by the Company, its major service providers,
vendors, suppliers or customers, could have a material adverse effect on the
Company's operations. Although the Company does not anticipate any major non-
compliance issues, some of the possible consequences of non-compliance by the
Company or its material third parties include, among other things: temporary
plant closings; delays in the delivery and receipt of products and supplies;
invoice and collection errors; and inventory obsolescence. It is currently
estimated that the aggregate cost of the Company's year 2000 efforts will be
approximately $12 million, of which approximately $10 million has been incurred
to date. All of these costs are being funded through operating cash flow.
These amounts do not include any costs associated with the implementation of
contingency plans.
The Company's year 2000 readiness plan is an ongoing process, and the estimates
of costs and completion dates for various components of the program as
described above are subject to change.
<20>
THE QUAKER OATS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Statement on Forward-Looking Statements
Forward-looking statements, within the meaning of Section 21E of the Securities
Exchange Act of 1934, are made throughout this Management's Discussion and
Analysis. Statements that are not historical facts, including statements about
expectations or projected results, are forward-looking statements. The
Company's results may differ materially from those suggested by the forward-
looking statements. Forward-looking statements are based on management's
current views and assumptions, and involve risks and uncertainties that could
significantly affect expected results. For example, operating results may be
affected by factors such as: actions of competitors; changes in laws and
regulations, including changes in governmental interpretations of regulations
and changes in accounting standards; customer demand; effectiveness of
spending, investments or programs, including cost-reduction projects; changes
in market prices or rates; fluctuations in the cost and availability of supply
chain resources; foreign economic conditions, including currency rate
fluctuations; weather; and the ability of the Company, and its major service
providers, vendors, suppliers and customers, to adequately address the year
2000 issue. In addition, capital expenditures and cash dividends may be
affected by the amount of cash flow from operating activities; restructuring
actions may be affected by the amount of reserve balances; and the Company's
market risk exposures may be affected by actual changes in market prices of
derivative financial and commodity instruments if actual changes differ from
the hypothetical changes used in sensitivity analyses. Forward-looking
statements speak only as of the date they were made, and the Company undertakes
no obligation to update them.
<21>
PART II - OTHER INFORMATION
Item 1 Legal Proceedings
Note 2 in Part I is incorporated by reference herein.
Item 4 Submission of Matters to a Vote of Security Holders
(a) The Company's Annual Meeting of Shareholders was held on May 12, 1999.
The matters voted upon at the Meeting are described in (c) below.
(c) (i) To elect two directors in Class I to serve for three-year terms
expiring in the year 2002 or until their successors are elected
and qualified. All nominees are named below.
- J. Michael Losh
Votes For Election - 118,869,761
Votes Withheld - 2,763,326
- Walter J. Salmon
Votes For Election - 118,321,536
Votes Withheld - 3,311,551
There were no votes against, abstentions or broker non-votes
with respect to the election of any nominee named above.
(ii) To ratify the Board of Directors' appointment of Arthur Andersen
LLP as independent public accountants for the Company for 1999.
Votes For Proposal - 120,217,314
Votes Against Proposal - 907,028
Votes Abstaining - 508,743
Broker Non-Votes - 0
Votes Withheld - 0
(iii) To approve the adoption of The Quaker Executive Incentive Bonus
Plan.
Votes For Proposal - 111,887,862
Votes Against Proposal - 8,192,978
Votes Abstaining - 1,552,044
Broker Non-Votes - 202
Votes Withheld - 0
<22>
PART II - OTHER INFORMATION - (CONTINUED)
(iv) To consider a shareholder proposal regarding annual election of
directors.
Votes For Proposal - 56,688,122
Votes Against Proposal - 53,648,918
Votes Abstaining - 1,386,219
Broker Non-Votes - 9,909,828
Votes Withheld - 0
(v) To consider a shareholder proposal regarding the Shareholder
Rights Plan.
Votes For Proposal - 59,058,900
Votes Against Proposal - 51,124,877
Votes Abstaining - 1,539,476
Broker Non-Votes - 9,909,833
Votes Withheld - 0
Item 6 Exhibits and Reports on Form 8-K
Item 6(a) See Exhibit Index.
All other items in Part II are either inapplicable to the Company during
the quarter ended June 30, 1999, the answer is negative or a response
has been previously reported and an additional report of the information
need not be made, pursuant to the Instructions to Part II.
<23>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Quaker Oats Company
(Registrant)
Date: August 3, 1999 /s/ Terence D. Martin
Terence D. Martin
Senior Vice President - Finance and
Chief Financial Officer
Date: August 3, 1999 /s/ Richard M. Gunst
Richard M. Gunst
Vice President and
Corporate Controller
<24>
EXHIBIT INDEX
Exhibit Paper (P) or
Number Description Electronic (E)
27 Financial Data Schedule E
<25>
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<PERIOD-END> JUN-30-1999
<CASH> 190
<SECURITIES> 153
<RECEIVABLES> 405
<ALLOWANCES> 27
<INVENTORY> 288
<CURRENT-ASSETS> 1,207
<PP&E> 1,793
<DEPRECIATION> 740
<TOTAL-ASSETS> 2,569
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<BONDS> 749
0
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<COMMON> 840
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