Filed by The Quaker Oats Company
Pursuant to Rule 425 under the Securities Act of 1933
Subject Company: The Quaker Oats Company
Commission File No.: 001-00012
PepsiCo and Quaker Oats will file a proxy statement/prospectus and other
relevant documents concerning the proposed merger transaction with the SEC.
INVESTORS ARE URGED TO READ THE PROXY STATEMENT/PROSPECTUS WHEN IT BECOMES
AVAILABLE AND ANY OTHER RELEVANT DOCUMENTS FILED WITH THE SEC BECAUSE THEY WILL
CONTAIN IMPORTANT INFORMATION. You will be able to obtain the documents free of
charge at the website maintained by the SEC at www.sec.gov. In addition, you may
obtain documents filed with the SEC by PepsiCo free of charge by requesting them
in writing from PepsiCo, Inc., 700 Anderson Hill Road, Purchase, New York 10577,
Attention: Secretary, or by telephone at (914) 253-2000. You may obtain
documents filed with the SEC by Quaker Oats free of charge by requesting them in
writing from The Quaker Oats Company, 321 North Clark Street, Chicago, Illinois
60610, Attention: Corporate Secretary, or by telephone at (312) 222-7111.
PepsiCo and Quaker Oats, and their respective directors and executive officers,
may be deemed to be participants in the solicitation of proxies from the
stockholders of PepsiCo and Quaker Oats in connection with the merger.
Information about the directors and executive officers of PepsiCo and their
ownership of PepsiCo shares is set forth in the proxy statement for PepsiCo's
2000 annual meeting of shareholders. Information about the directors and
executive officers of Quaker Oats and their ownership of Quaker Oats stock is
set forth in the proxy statement for Quaker's 2000 annual meeting of
stockholders. Investors may obtain additional information regarding the
interests of such participants by reading the proxy statement/prospectus when
its becomes available.
PEPSICO INCORPORATED
12-04-00/8:00 a.m. CT
Confirmation #496950
PEPSICO INCORPORATED
MODERATOR: MS. KATHLEEN LUKE
DECEMBER 4, 2000
8:00 A.M. CT
Operator: At this time for opening remarks and introductions I would
like to turn the call over to Ms. Kathleen Luke, Vice
President of Investor Relations. Please go ahead ma'am.
Kathleen Luke: Thank you and good morning. I'm Kathleen Luke, Vice
President of Investor Relations for PepsiCo. Here in New
York joining me are Roger Enrico, and Quaker's Bob Morrison.
In Chicago we have Sue Wellington, head of US Beverages,
that's Gatorade and the three food heads, Polly (Coalis) Hot
Breakfast, Chuck (Muskalco), Convenience Foods and Margaret
(Stender), Ready to Eat.
I'd like to thank you all for joining us this morning
particularly on such short notice. As I hope you know, this
morning we announced some very exciting news. We have
reached an agreement under which PepsiCo will combine with
the Quaker Oats Company. And that's what we'd like to talk
about today. In a moment I'll turn the call over to Roger
Enrico, Chairman and Chief Executive Officer of PepsiCo.
But before I do that please bear with me while I read our
Safe Harbor language. This presentation contains certain
forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements
are based on management's current expectations and are
naturally subject to uncertainty and changes in
circumstances.
Actual results may vary materially from the expectations
contained herein. The forward-looking statements contained
herein include statements about future financial operating
results and the benefits of the pending merger between
PepsiCo and Quaker Oats.
Factors that could cause actual results to differ materially
from those described herein include the inability to obtain
shareholder or regulatory approval, action of the US,
foreign or local government, the inability to successfully
integrate the businesses of PepsiCo and Quaker Oats. Costs
related to the merger, the inability to achieve cost cutting
synergies resulting from the merger, changing consumer or
marketplace trends, and the general economic environment.
Neither PepsiCo nor Quaker Oats is under any obligation to
and expressly disclaimed any such obligation to update or
alter this forward-looking statement whether it was the
result of new information, future events or otherwise. We
urge investors to read the proxy statement prospectus or any
other relevant documents that PepsiCo and Quaker Oats have
filed or will file with the Securities and Exchange
Commission because they contain important information.
Thank you for your patience. Now let me turn the call over
to Roger Enrico.
Roger Enrico: Well good morning. I'm delighted that so many of you have
been able to be with us this morning both on this conference
call and I'm sure many more on the world wide web on the
PepsiCo Web site which is simulcasting this call.
We're happy that you're here with us at what is I think one
terrific moment in the history of PepsiCo and Quaker. And
what I'd like to do this morning is walk you through this
historic combination. And if you'll bear with me with some
patience this may take some time. But I'll try to
communicate as clearly as I can what we believe are the
benefits and why we are so enthusiastic about this
combination of PepsiCo and Quaker.
I'll take you through the structure of the deal, the
financials that we expect, our strategic value that we see
in this combination, the hard synergies that we expect this
combination to bring about. And what you might expect of
PepsiCo from a financial perspective after this combination
is completed, along with a discussion of our implementation
plans and the leadership team that will be driving this
company going forward. And then of course we're going to
take your questions.
Now one of the things that you will hear me say repeatedly
throughout this discussion is this is conservative and this
is not in the model and this assumption is not rolled into
our numbers. Basically what we have done here is I think as
you'll agree as you listen to what I have to say is modeled
a very, very conservative approach in terms of what we have
put into the numbers that we'll you about with regard to
this combination.
So listen carefully if you would please to what's in and
what's not in the numbers. We obviously expect and will
charge our people with performing against all of the
synergies and strategic values we see but keeping with our
practice at PepsiCo of being very conservative in the
expectations that we set for investors. And to be a
consistent performer that outperforms expectations, we have
modeled this business combination conservatively.
Let me go first now to the transaction terms. This will be a
transaction on a pooling basis with 2.3 PepsiCo shares
exchanged for each share of Quaker Oats. At Friday's close
that makes the offer value at about $13.3 billion. The
mechanics of the deal are that the deal price, if you will,
is capped at $105 per Quaker share. And that would mean a
PepsiCo stock price of $45.65.
Now below a PepsiCo stock price of $40 which would at 2.3
mean a Quaker value of $92. The Quaker Oats Company has the
right not to conclude this deal unless PepsiCo should choose
to top up the exchange to equal the $92 minimum. At above
$105 a Quaker share, in other words above PepsiCo share
price of $45.65 the exchange ratio would decline so that
Quaker shareholders would receive a value equaling $105 a
share.
Assuming that the 2.3 exchange ratio will in fact be
implemented that is the share prices will be somewhere below
the cap if you will, the pro forma ownership of the new
company once the deal is completed would be 83% of PepsiCo,
present PepsiCo shareholders and 17% present Quaker Oat
shareholders.
We have included in our agreement a deal protection
mechanism which includes a $420 million breakup fee should
Quaker for some reason choose not to proceed with this deal
other than of course the walk away for a minimum price. And
the ability for PepsiCo to exercise up to a 19.9% option on
Quaker stock. We would expect this deal to close sometime
between the first quarter and the second quarter of next
year, 2001.
So that's the deal mechanics. Now before I talk about what
Quaker brings to PepsiCo, let me step back if I may and
remind you that since our restructuring PepsiCo has been
already operating at a new and higher level. We have
refocused our corporation to participate in three high
growth businesses, refreshment beverages, enhanced or
functional beverages, specifically with Tropicana juice
portfolio and the salty snack business.
From that overall goal of participating in the convenient
food and beverage market worldwide, a huge market with very
good growth, both historically and prospectively, we have
set clear financial objectives for PepsiCo. And those
objectives have been that we would generate 6% to 7% top
line growth in the company, that is sales revenue growth.
And that would yield an operating profit growth from our
divisions of about 10% to 11% per year.
And with some leverage that we get below the line from
interest and corporate expenses and share repurchases and
the like, that would yield 12% to 13% earnings per share
growth consistently. And with the kind of discipline that we
have put into this company with regard to capital
expenditures and the management of cash, we would expect our
business to grow - our return on invested capital I should
say to grow by 50 to 100 basis points per year.
Now that financial discipline that we have put into this
corporation has resulted now in five quarters of consistent
solid growth in which we have met or exceeded all
expectations. And we expect this quarter, the fourth quarter
of 2000, to meet expectations as well. And that will result
in a full year EPS growth rate for PepsiCo well above mid
teens for 2000.
In addition to the income and performance that this
corporation has delivered over the last five and now six
quarters, we have employed stringent strategic criteria and
extremely tight financial screens as we look at all kinds of
capital expenditures. Whether those be for plants and
equipment or for acquisition activities. And as a result
share repurchases have been a major element in our portfolio
over the last several years having bought back nearly $9
billion worth of PepsiCo stock.
Now, we're delighted that this combination of PepsiCo and
Quaker meets the lion share of our strategic criteria. Plus,
it absolutely passes the rigorous financial screen that
we've had in place here for acquisition activities.
So what does this deal all add up to financially, giving you
the base level of what PepsiCo was doing and will continue
to be able to do? The fact is that our corporation has a
great deal of scale. There is no compelling, strategic void
that requires us to do an activity - an acquisition activity
like this. So what does this all add up to in terms of the
combination of Quaker and Pepsi?
Well the headline here is that the combination is going to
solidify our growth prospects but more importantly, enhance
them going forward. Now we've used a conservative base model
for Quaker and we have been conservative as I suggested
earlier in modeling synergies. And the results that we
expect from all of this, even with the conservatism are
terrific.
First of all, we expect the combination to enhance the top
line. We were as I mentioned, expected to grow at 6% to 7% a
year. We now believe we can deliver upwards of 7% growth
going forward on a consistent basis.
Secondly, it enhances EBIT growth. We committed as I
mentioned to 10% and 11% operating profit growth from our
operating divisions with modest synergies that I'll detail
in this conversation. We will add a percentage point to that
growth rate going forward looking at 11% to 12% EBIT growth
from this combined company.
Thirdly, it will enhance EPS growth. I said we expect 12% to
13% growth for PepsiCo. We now expect our pro forma combined
company to do 13% to 14% earnings per share growth going
forward.
And finally, return on invested capital. The combination of
Quaker and Pepsi will immediately improve PepsiCo's return
on invested capital by almost 200 basis points, in as much
as Quaker has as it stands, a higher ROIC than does PepsiCo.
And over the next five years, by year five, we expect the
return on invested capital of PepsiCo to improve by over 600
basis points. All in all, I think you'll agree, an excellent
financial outcome.
Now we'd like to walk through this transaction and lay out
what I see as the strategic fit between PepsiCo and Gatorade
- and Quaker, excuse me. I'll start with Gatorade. Now
clearly base Gatorade did the most important part of the
portfolio that's being added into the PepsiCo Corporation.
It is a powerhouse brand generating $2.1 billion in sales
with a three year historical growth rate of 12% in sales and
15% a year in profits.
Now in creating a base case if you will for the Gatorade
business in a model, we projected growth rates going forward
that are less than that three year historical growth rate I
just mentioned. In fact we are expecting a bit better than
9% growth in revenues versus the 12% that Gatorade performed
over the last three. And an EBIT growth rate of around 13.5%
less than the of course 15% growth over the last three
years.
Now, our conservatism in all of this has absolutely nothing
to do with confidence in the Gatorade brand. This clearly is
one of the best brands in anything in consumer products in
the United States today. It has one of the greatest track
records of brands, not only over the last three years but
over the last 40 years, virtually, since it was acquired by
Quaker Oats.
We are simply again being conservative in our modeling so
that this is all about PepsiCo will continue to be all about
meeting and exceeding expectations. Now Gatorade is a great
story in and of itself but it's even better when you see
what Gatorade brings to PepsiCo.
So let me start first by talking about PepsiCo's beverage
portfolio within the US and International beverage market.
Now in the United States we have - you can think about it.
We have two beverage businesses within PepsiCo. We have a
Pepsi Cola refreshment beverage portfolio and we have a
Tropicana functional beverage portfolio.
Now within the Pepsi Cola refreshment beverage portfolio we
have carbonated soft drinks and we have non-carbonated soft
drinks. Now most of our portfolio presently is carbonated
soft drinks, about 90%. Ten percent of our portfolio on the
Pepsi side is non-carbonated soft drinks. And of course that
is the most rapidly growing part of our business with
Aquafina, with Lipton teas, with Frappacino and with
FruitWorks, and soon to be added the Dole line of juices
into the Pepsi system.
On the Tropicana side of the business we can kind of look at
this in two ways. One is we have a chilled business,
Tropicana not from concentrate pure premium and others. And
we have a shelf stable or ambient business, such items as
Tropicana Twister juice drinks. Our business breaks down
about 80% chilled in Tropicana and 20% shelf stable or
ambient.
Now for the purposes of this discussion going forward I'd
like you to think about a business that incorporates the
non-carbonated soft drinks part of the Pepsi Cola portfolio
and the juice business that we have with Tropicana, both the
ambient part and the chilled part and then graph Gatorade
into this combination. So the addition of Gatorade to
PepsiCo significantly enhances clearly our share of
non-carbonated beverage business in the United States.
Along with the addition of (Sobee) in the number, PepsiCo
will have a 25 share of the non-carbonated beverage
business. And that will be about 1.5 times the next largest
player. Now it's not just the starting point we're excited
about. It's the growth prospects. Now non-carbonated
refreshment and functional beverages are about 28% of the
total beverage market in this country. And they're growing
at 8% to 9% a year as compared to the carbonated beverages
in the marketplace growing at say 2% to 3% a year.
Now, so the addition of Gatorade has strengthened the growth
prospects of our portfolio significantly. But clearly there
is more. Now what I'd like to do is kind of walk you through
the synergies that we see coming out of Gatorade and PepsiCo
being combined.
Now, clearly, there is an opportunity to increase
penetration of Gatorade in the United States and abroad. But
let me think about the United States now and I'd like to
walk you through these opportunities kind of channel by
channel because they're quite different as you think about
the various ways of getting product to market and to various
kinds of customers.
First of all, think about the large format stores out there.
These are the supermarkets, the warehouse clubs, the large
stores. Gatorade is already distributed, extremely cost
effectively through their warehouse system. And we do expect
this to continue. You think about Gatorade's presence in
those kinds of stores and its availability, the range of
SKUs that are available. Clearly the Quaker Oats Company has
done a superb job of bringing that product to market through
large format stores. And we think that would just continue.
The second group or channel I'll talk about are chain
convenience stores and the like. Now in this case Gatorade
has also distributed very effectively through a broker
system. Again if you think about going into a 7 Eleven or a
Circle K out there you will find a wide range of Gatorade
SKUs available, well merchandised in the cold vault. And
again the Quaker Oats Company has done an excellent job and
their sales organization has done an excellent job of
getting that product out.
And I would say that this is highly likely to continue as is
unless there is some sort of (inaudible) in any kind of
region in the country. In which case obviously we have the
ability to fall back upon if you will or to look to the
Pepsi bottling system on a selective basis.
Now the third sort of group or channel I'll describe here is
what I'll call for the purposes of this discussion, the
unorganized channel or the old way of saying it I guess were
the moms and pops but I don't think we're really talking
about moms and pops anymore. Now here we clearly can
selectively put Gatorade through the Pepsi bottling system
where we have under-served regions and under-served
customers.
In addition there are also have opportunities in vending and
schools. So in delis and the moms and pops and the small
convenience chains and the schools and the vending and so on
and the like there is a clear opportunity. Because
Gatorade's penetration and presence and availability is no
where near in those kinds of accounts the high level it is
in the organized C stores and in the large format.
So clearly that benefit is there. A number of people have
written about that. We absolutely believe that will be an
opportunity for Gatorade and PepsiCo. But I want to tell you
that we have not modeled any top line growth synergies from
this. So as relates to the Gatorade business, okay, we
expect Gatorade to grow at the rates that I described
earlier in the base case. That is, a little over 9% of
revenue growth and something around 13.5% in profit growth
and that's what's in the model that we're talking about this
morning.
Now turning to International, Gatorade International is
presently a $380 million business. And clearly there are
opportunities to increase the availability and presence
working with our Pepsi Cola International bottling system
and even with our Frito-Lay International capabilities
around the world. Those opportunities are not that
dissimilar from the ones that I just described for the
United States. But again in modeling this merger, this
combination of companies, we have assumed zero upsides from
the international business.
So let me turn now to where we see some very real hard
synergies. And the big story here is Tropicana. Now as I
mentioned, the Tropicana business has two parts. The chilled
business representing 80% of it's portfolio, Tropicana Pure
Premium being the biggest brand. And the ambient business,
Tropicana Twister, Season's Best and so on which represents
20% of the portfolio.
Now the thing to know about the ambient business is to think
about the market. It is a big market, it's about $7.5
billion in the United States and it's been growing at over
3% a year. The second thing to think about that business,
the ambient market if you will, it is a - it is highly
fragmented. Now Tropicana's juice portfolio, unlike Pepsi's
beverage business, goes to market through a broker warehouse
system much like Gatorade does.
However, Tropicana especially on the shelf stable or ambient
side lacks the national scale and presence that Gatorade has
which we recognize is in part, that is the Gatorade
presence, we recognize is in part as a result of the overall
scale of the combined Quaker food business as well, and
Gatorade. So piggybacking off of this scale broker warehouse
and commercial organization, the major account sales, broker
management and so on, we believe could result in significant
benefits for Tropicana.
Now let me give you a bit more detail on that. In the large
format stores, as I mentioned earlier, Gatorade has
extremely good presence, extremely good availability of
SKU's and is extremely well merchandised. And it happens to
be merchandised in the same aisle as this - these ambient
products I've been talking about, Tropicana ambient and the
other ambient juice drinks and the like.
A combination of Gatorade and Tropicana will give PepsiCo a
12% to 13% share of the large format alternative beverage
aisle business. And what this does is gives us the
legitimacy to be the category captain of the alternative
aisle. That means that we would be the preferred partner
with retailers on an intellectual basis and a know how basis
to help retailers to unclutter the aisle, to improve the
turns in the aisle, improve the cash flows profitability and
so on.
As I said, this aisle is extremely fragmented in clutter and
if any of those of you would choose to go out into a
supermarket after we finish if you walk down that aisle you
will certainly see what I'm talking about. So we believe
there is a significant amount of upside capability from
combining the Tropicana and the Gatorade go to market system
and sales and marketing capability in terms of the benefit
being to significantly improve our sales of Tropicana
ambient products.
Now outside of the large format stores and again in C
stores, Tropicana will be able to take advantage of
Gatorade's excellent presence as I mentioned before to get
more presence for itself in the all important cold vault
where the margins are high. Now this is definitely a top
line opportunity that we are excited about.
And let me tell you how we've included this in our model. So
what's in the model here now is that over the next five
years Tropicana's ambient business in combination with
Gatorade will grow significantly. We believe what we can
grow that business to be up 50% from what it currently is in
large format stores and up by three fold or 300% in small
format stores.
Now the net incremental benefit of that to PepsiCo would be
$400 million in additional revenue by year five. And the
operating profit flow through of that additional revenue
would add $45 million pre tax to our bottom line by year
five.
Now, this upside of Tropicana ambient beverages is the only
beverage top line synergy opportunity we have modeled in the
financial case for this combination. And that sits upon what
I believe is already a relatively conservative base case of
9.5% thereabouts for revenue growth on Gatorade and 13.5% in
profit growth.
Now let me turn away for the moment on the beverage side
here from top line synergies and top cost synergies
resulting from Gatorade and the rest of the Quaker portfolio
being part of PepsiCo. The first major bucket here is
procurement savings. Now clearly the overall scale of
PepsiCo and Quaker combination can help reduce costs of
direct materials like (PEG), cartons, et cetera, as well as
that of all other goods and services.
And while the procurement savings as I mentioned sort of
apply to all of Quaker, we're going to model it here in
beverages since it's the largest single contributor. Now
we've included $60 million of benefits, pre tax benefits by
year five from purchasing savings. Now frankly we're pretty
confident that we can get a lot more than that. But again,
in keeping with the overall theme of conservatism, we feel
comfortable with committing to this number at this time.
Now the next element to think about, excuse me, on cost
savings is that Tropicana and Gatorade and for that matter,
the Quaker non-snack food business are warehouse delivered
products. And we believe there are considerable savings
available through consolidating the go to market
capabilities of the combined companies.
Now Tropicana, Gatorade and other Pepsi Cola products like
Lipton, (Sobee) (Frappacino) are all hot fill products. And
we think there are opportunities for better system capacity
rationalization and therefore cost reduction as we will be
able to manage all of these things now in a coordinated way.
There is also a significant cost reduction opportunity in
looking at the overall supply chain in adding to the
manufacturing and selling things that I've mentioned, the
warehousing and logistics. So between the SG&A effect of
this rationalization if you will, and the rationalization
relating to hot fill, again conservatively modeled, we
expect to realize an additional $65 million pre tax savings
by year five.
Now, there's a third area of opportunity from this Gatorade
PepsiCo acquisition or combination I should say which is
truly, truly exciting. And this relates to laying the
pipeline for the future building capabilities starting with
R&D.
With the Gatorade Sports Science Institute and the Tropicana
Nutrition Center, we will lead the beverage industries
capability in nutrition and physiology. And we will have the
beverage industry's leading expertise in functional beverage
manufacturing technology as well... capabilities of
continuing to generate profitable topline growth.
Let me turn our attention just a second back to the
international side of things. Under what I'll described as
sort of international network building.
If you think about putting Tropicana, Gatorade, teas and the
like together, we can now justifiably selectively justify
selectively building or making it attractive for others to
put in hot fill production capacity in some regions of the
world. And that creates tremendous growth opportunities for
the company. That's an opportunity that would be difficult
for us to capitalize on now without the kind of scale that
this combination might bring about.
Again, keep in mind, we haven't modeled any upsides from
those sorts of capabilities. So let me now summarize if I
can, the Gatorade, PepsiCo, beverage story. First, what's in
the model. What's in the model is Gatorade based volume -
base case, excuse me, a little over 9% revenue growth and
13-1/2% EBIT growth.
And added to that we had $400 million of incremental
revenues of the Tropicana ambient business by year five, and
the profit flow-through resulting from that of $45 million
pre-tax. In addition to that, we expect by year five, $60
million procurement savings, and $65 million of other cost
savings relating to SG&A, hot fill manufacturing, logistics,
the go to market combination and the like.
What's not in the model is the Gatorade sales benefit from
Pepsi-Cola's US and international system capability or the
new innovation capability from combined R&D and marketing
know-how.
Now I'd like to turn your attention to the other pillar of
PepsiCo which is snacks. Now virtually all the focus up to
this moment in the press and with me here now this morning
has been - virtually everything anyone talks about is
Gatorade. And that's understandable considering the
powerhouse brand that is it.
But we think this combination gives us a great deal more
than that. It gives us a terrific second brand in Quaker
itself, and a great business in snacks. Now as you know,
Quaker is already in snacks, rice cakes and bars -- granola
bars and the like -- with a portfolio of leadership products
and brands. They presently have a $380 million business
which has grown at 10% in revenues in EBIT over the past
three years.
I think you're also quite familiar with Frito-Lay's strategy
that we articulated a little over a year ago that we call
the add more strategy. That is to selectively build out from
our powerhouse core salty snack business adding - growing
out from that core to add products now that perhaps are not
salty snacks but are close-in type of products in terms of
the way consumers would consume them.
And to make that add more strategy a reality, we have been
reengineering the Frito sales organization in our pre-pick
system which will help us to increase capacity, in crease
the number of SKUs that we can effectively handle through
the Frito-Lay system which would allow us to immediately
distribute these products through Frito-Lay and realize
upsides.
Now, let's talk a little bit about the model assumptions
here for the Quaker snack food business in combination with
PepsiCo. I said that the - over the last three years that
the EBIT and revenues in EBIT have grown at 10%. We are
assuming a base growth rate for that business of 8% in
revenues and just shy of 11% in EBIT going forward.
Now given - in combination with PepsiCo and Frito-Lay's
distribution capability in the United States, we would
expect to significantly increase the revenues of that snack
food business. In fact I think we believe that we can quite
conservatively double that business which would add - double
the rate of growth I should say of that business, which
would add $200 million with the revenues by year five. And
the flow-through of pre-tax basis for that would be $34
million.
So we'd have a business in the base case growing at 8% and
aisles accelerating to mid teens in sales adding $200
million more than otherwise would be the case, a profit
growth rate in the base case of just shy of 11% to which we
would add $34 million by year five of incremental pre-tax
profits.
This does not include international upsides from leveraging
exactly the same thing which we of course know exists but
we've chosen not to model in at this time.
Now to us here at PepsiCo, the even more exciting story
about the Quaker brand here is that as with beverages, the
growth platform that the Quaker snack food business brings
to us is truly exciting. If you think about what's going on
in the consumption of meals in the United States, and in
fact, in many countries in the world today, we have a
continuation of the - as they say, the deconstruction of
meals.
What it simply means, is more and more people are getting
their nutritional and caloric intake on an on-the-go basis.
And it seems as though the same consumer trend which is
effecting beverages and the tremendous growth of single
serve and cold bottle beverages is also effecting the way we
consume food products. We are moving toward the sweet spot
of convenient food and beverages of one-handed meals,
on-the-go eating.
And clearly that has been the case up to now for fun foods.
That in fact is the way fun foods are consumed. We see this
market migrating over the years into something more than fun
foods, as a legitimate way for people to get their
nutritional needs or part of their nutritional needs for the
day. And I believe that that is going to be a huge business
in this country.
Now it's already quite big. If you think about it, the way
it's manifested most clearly today is in the bar business.
We have granola bars. We have protein bars. We've got energy
bars and the like. And those business right now are about $2
billion. That is, the market's about $2 billion. It's
growing at 9% a year. And I think as I said, that consumer
trends are going to sustain if not accelerate this growth
rate going forward.
Now you can think about it this way. As consumers look for
nutritious snacks for some day parts, bars are an ideal way
to kind of smuggle the nutrition in to the fun. Now today,
PepsiCo is not in this business although we have identified
it as a critical add more need. Now with Quaker Oats, we get
a bar business that gives us legitimacy over night in this
category. We get the brands, the products and the R&D in
manufacturing and marketing expertise.
In addition, we get some very important strategic
capabilities. The Quaker brand name allows us to build now a
morning snacking business, a segment of the day that's
undeserved by Frito-Lay. The Gatorade mark allows us to
build an afternoon snack business. And for those of you that
have not had the opportunity to taste the new Gatorade
Energy Bar, I encourage you to do so. I think it is clearly
the best tasting energy bar on the market bar none.
And the Quaker trademark as I said, gives us the legitimacy,
the nutrition credentials if you will, to think about
effectively playing in all of this and being a leader in
this whole trend.
So the net net of all of this, is I can say that the Quaker
snack business may only be about 8% of their present
portfolio. But it sure has a much higher share of excitement
to us at PepsiCo.
Now let me turn the attention to the balance of the Quaker
portfolio. And for the purpose of this discussion just to
keep it simple, let's call it the non-snack food business.
Now first and foremost, I want to go on record as saying,
the non-snack food business is a good business. It has sales
estimated this year of %2.6 billion. It has an EBIT margin
of about 17%. It has had a four-year EBIT growth rate of
about 4%. And it throws off a relatively prodigious amount
of cash.
Now, to put it all in perspective, when we combine PepsiCo
and Quaker, this non-snack food business will represent
about 10% of pro forma PepsiCo sales and about 11% of EBIT
day one. And it is that we do not expect - inasmuch as we
don't expect it to grow as fast as the rest of our
portfolio, that percentage will go down over time.
The non-fat food business of Quaker has great leadership
brands like Quaker Oatmeal, Life, Cap'n Crunch, Aunt Jemima,
Rice-a-Roni, et cetera. And most of the brands that are in
this portfolio, have leadership shares in their category.
I'd also say as I mentioned earlier, that the scale of this
non-snack food business is important to the overall
warehouse go-to-market capability that will generate
synergies for our Tropicana portfolio. And this business has
been managed extremely well by the Quaker management team,
which we intend to lock in -- that is the management team --
so that they can continue to deliver the great results that
they've been posting for the last number of years.
So we've modeled this non-snack food business to deliver
conservative revenue growth of 3.3% over the next five years
and what I think is modest profit growth of 4-1/2% a year
over the next five years. Now I would think about this
business as one with consistent predictable earnings with
some upsides now and then.
Now clearly in no way does the presence of non-snack foods
in our portfolio change PepsiCo's core strategy to focus on
three high-growth business -- refreshment beverages,
functional beverages and snacks. We have no plans, no
intention for non-snack foods to evolve into a fourth
strategic leg for PepsiCo.
Now that summarizes the lines of business, their outlook in
synergies. Let me turn now to another smaller set of
synergies that come from a combination of corporate G&A and
multiple other sources.
Now we've modeled modest reductions for this whole bucket of
sort of corporate redundancies that get created because of
this combination to add up to $26 million pre-tax by year
five.
So just to recap now our financial projections, standalone
PepsiCo is expected to deliver revenue growth of 6% to 7%
and EBIT growth of 10% to 11%. As a result of the
combination with Quaker, we've layered in synergies of $230
million pre-tax by year five of which we expect $65 million
will be realized in year one.
And when you add together all of the top and bottom signed
synergies, the resulting algorithm is accompanied with
revenues growing at 7% plus and EBIT at 11% to 12%.
Now let me turn our modeling assumptions to below the
operating profit line to kind of fill out the income
statement for you starting with interest expense.
Net interest expense pro forma 2000 for PepsiCo will be
about $215 million. Now pooling as you know, requires us to
cease share repurchases causing cash to build up on our
balance sheet. So net interest expense will come down to $50
million by year two -- by year two after the deal is
completed. And we will have around $5 billion in cash with
some modest levels of debt.
Now after two years, the rules allow us if we so chose,
we're free to repurchase shares. And if we look out to year
five, we estimate net interest expense for the combined
PepsiCo to be somewhere around $200 million a year.
Now let me turn to the tax rate. Let me mention by the way,
that the interest expense numbers that I just described are
in the model, the financial model for the combination. Now
turn to the tax rate.
We've assumed Quaker's tax rate at 34%. As you know,
PepsiCo's is presently 32%. So just working the arithmetic,
the pro forma tax rate's 32.4% for... PepsiCo are working
independently on tax strategies combining this - if you
combine this with the opportunities resulting from working
together.
Now we expect the outcome of the work we're doing now to be
a reduction of the combined company's tax rate by 1 to 2
points within the first two years after close. However we
have not modeled what we believe will be a significant tax
benefit into our financial projections at this time for the
combination.
Now moving from income to cash, let's talk a little bit
about cap ex or capital expenditures. If we were to simply
add our respective company's cap ex's tog4ether, the result
is a capital expenditure rate of approximately 5.5% of sales
year one. Cap ex projections for the two companies
independently combined with the topline synergies from the
combination that I've talked about, cause this cap rate to
come down to approximately 4-1/2% by year five. Now this of
course doesn't include any cap ex for any ongoing or further
tuck-in acquisitions, you know, principally for the
Frito-Lay and the soft drink business of PepsiCo. And this
is what we've modeled into our cap ex assumptions.
Again we believe that that's a conservative approach and we
think there are upsides to what I just said. Because as we
jointly work on supply chain rationalization, cap ex needs
are likely to go down further. And the sheer scale of the
combined company will allow us to procure capital equipment
more efficiently. Again, we haven't modeled in any of these
efficiencies, merely the base assumptions that I've
described earlier.
Now as we kind of come down to the cash line if you will, in
our modeling, we've sort of mentally set aside and estimated
$400 million for merger-related restructuring costs. Now
that's about typical for deals of this size. And to be
conservative again, we're going to assume for the moment
that all of that $400 million's going to be cash cost,
unlikely but we'll assume that to be conservative, and that
it'll be spent in the first two years.
Now over the next few months, obviously we're going to work
to refine these numbers and provide you with a more accurate
picture of what that is likely to be. But year one, the pro
forma free cash flow per share which as I'll remind you,
excludes dividends, share repurchases, ongoing acquisitions,
et cetera, is modestly diluted.
Beyond year one, cash flow per share will be accretive as we
expect cap ex requirements to decline and as the cash
benefits of the profit synergies flow through. Cumulatively,
that is adding up all the first five years together, based
upon this conservative model that I've taken you through, we
expect free cash flow per share to increase by roughly 20
cents a share over the next five years setting aside the
merger expenses.
So if I may let me kind of try to roll all this together for
you again. New PepsiCo revenue growth goes up from 6% to 7%
to a solid 7% plus. EBIT growth goes up a whole percentage
point from 10% to 11% to 11% to 12%. Earnings per share goes
up a point from 12 to 13 expected to 13 to 14 expected.
Return on invested capital goes up 200 basis points closing,
and then improves to 600 basis points improvement by year
five.
The deal we would expect is 1 to 2 cents accretive to
earnings per share in its first full year. And this
combination of PepsiCo and Quaker creates multiple new
avenues to accelerate the growth of our refreshment
beverage, functional beverage and snack food portfolios.
So now I hope you can see and I hope you share our
excitement about this combination.
A little note on 2001, as I'm sure you'd all like to kind of
work the models as quickly as possible. As of now of course,
we have no way of knowing when the deal will close. We
expect it will happen in four to six months. Because of
timing on closing, I would recommend you not add much if
anything to 2001 EPS targets at this point.
2001 EPS guidance for PepsiCo has been 12% to 13%. I said -
as I said, I expect the combination to be 1 to 2 cents
accretive in the first 12 months post-merger. But deal won't
close until half way through the year. And the $65 million
in savings that we expect, that is the cost synergies
pre-tax, we expect to bring in in the first 12 months, are
going to build over time. So it's not going to fall equally
from the - between the first half of that period of time and
the second half. It will obviously go up the curve pretty
sharply into the second half of that first year.
So there you have it. There's now a new PepsiCo, stronger
than ever, still highly focused on three phenomenal growth
businesses -- snacks, refreshment beverages and functional
beverages. It's a company that will be among the largest of
the global food and beverage companies in terms of both
sales and EBIT. It's a company that will represent in the
United States, one of the most important partners for our
customers. We will continue to be the fastest contributor to
the growth of our retail customers, the most important
contributor to their profits, and the most important
contributor to their cash flow.
And we would expect with your confidence and help that we
will have a company with a market capitalization well North
of $80 billion -- a true powerhouse in convenient foods and
beverages.
Now that's the deal and that's the strategy and that's the
hard numbers and what we're so excited about. But let me
share with you now, switch over and talk about
implementation, because it's one thing to do a deal and have
the rationale and have all the arithmetic work. It's another
thing to actually get out there and make it happen.
And from the moment that Steve Reinemund and I and Indra
Nooyi for that matter, thought about this, we began thinking
about how do we deliver the goods? How do we implement? How
do we assure smooth and superb execution? And that's really
a question all about people. So I'd like you to think about
another important asset, maybe the most important asset that
will come in this combination to PepsiCo. And that's the
Quaker team.
I think those of you who have been investors in Quaker would
agree with me to say that over the last several years under
Bob Morrison's leadership as Chairman and CEO, this has been
a team that has delivered to the nines. It's a highly
professional, capable, extremely well performing team.
So I'm happy to say first of all, when we think about how
you assure execution, is you make sure that you have the
people who know all about it stay with you. And the first
person that I'm delighted to announce that will stay with us
is Bob Morrison himself. Bob is going to be joining PepsiCo.
He's committed to stay a minimum of 18 months after the
close. We are hoping and expecting that his arithmetic value
is about as good as (Carl Vanderhiten)'s who you may recall
came here some four years ago for a 12-month stint. And if
it works out way, we'll have Bob for a long time indeed.
Now as I thought about Bob's role changing with this
combination from CEO and Chairman of a public company, and
what he was doing in terms of the right thing I think he
believe and I certainly believe and I'm sure his
shareholders believed for his shareholders and for his
employees in agreeing to come on and joining us at PepsiCo
for this period of time at a minimum so that the
shareholders of the combined companies would see the
benefits that I've talked about here this morning, and that
the employees would see the opportunities that I've - kind
of implied this morning.
Anyway, as I've thought about Bob's willingness to do that
in the example of his unselfish willingness to do that, I
felt it was only fitting that I do the same thing. And so
therefore, I did recommend to our board of directors, some
management changes that will take effect upon the closing of
this deal.
Bob will as I said, join PepsiCo as Vice Chairman. And he'll
be elected to our Board of Directors. And Bob will also be
Chairman, President and CEO of Quaker and be an overall -
the single person most responsible for integrating Quaker
into PepsiCo and for -- along of course with Steve Reinemund
and others -- for realizing the benefits of this
combination.
Now Steve will at that time, become Chairman and CEO of
PepsiCo. As you know, we announced a number of months ago
that that was our intention and we would transition over the
next two years with sometime in 2001, Steve becoming CEO and
sometime in 2002, him becoming Chairman.
We decided that it makes a lot of sense to move that up, and
that's what we intend to do. Indra Nooyi will become
President of PepsiCo, responsible for all of the corporate
activities, and retain her Chief Financial Officer title and
be elected to the Board of Directors are well.
And I will join Bob as the Vice Chairman of PepsiCo. And he
and I will report to Steve once Steve becomes Chairman and
CEO of the company.
Now I'd just like sort of wrap this up with kind of a
personal statement if you will. I've never been more
enthusiastic about PepsiCo than I am at this moment. I am
extraordinarily enthusiastic about working with this team,
obviously continuing to work with the PepsiCo team that I
know and love and have come to know in this last month or so
especially, a number of the members of the Quaker team and
of course, Bob himself.
This earlier transition date that we're talking about
between Steve and myself, does not suggest a lessening of my
commitment of time or energy to PepsiCo in any way. And in
fact, I look upon this as the most exciting way I could
possible imagine to conclude if you will, my career at
PepsiCo over the next couple of years.
So with that, let me turn this discussion and meeting back
over to Steve Reinemund who will become the new Chairman and
CEO of PepsiCo to field your questions. Steve?
Steve Reinemund: Thank you Roger. And today is truly a defining moment for
PepsiCo and for Quaker. Along with everybody at both
organizations, I'm proud to be a part of such a defining
moment in the history of our combined companies. And I'm
obviously very pleased about the vote of confidence that
Roger and the board and the rest of the great PepsiCo
management team has given me. And I must say that the honor
of serving and the privilege of leading PepsiCo is more than
a little bit humbling when you consider the past trio who
have been the CEO and the legacies they have left at this
company.
And my enthusiasm for the opportunity to lead PepsiCo has
been incredibly strong over the past months since Roger made
this decision. But I have to say, today's development takes
it to completely a different level. And we were in my
opinion, a premier consumer products company before today's
announcement. But the combined PepsiCo and Quaker is truly
now in a league of its own.
And PepsiCo and I'm sure that Quaker feels the same way, we
often talk about what attracted us here and what it
inevitably comes down to is a thinking about our dynamic
businesses and our brands, the world-class talent that we
work with, and the chance to make a significant difference
with our personal impact. And I would have to say today's
news only strengthen those attributes for everyone on the
combined PepsiCo Quaker team.
I'd like to take just a moment if I can to mention Roger's
decision to move to Vice Chair. And it's certainly not
unusual for CEOs to turn over the reins. But I can't think
of another case -- I've never heard of another case -- where
the CEO turns them over and then he volunteers to stay on
and keep contributing. And I think it's just consistent with
the life time of commitment that Roger's made to PepsiCo and
the depth of his personal loyalty to this company.
I appreciate Roger's support and I intend to keep counting
on it. And he mentioned that he hoped that Bob's arithmetic
is not any better than (Carl)'s. And I would only add that I
hope that Roger's arithmetic is no better than either one of
them and that I can count on all three of them for many
years to come. And I must say that I treasure the friendship
that I've had with Roger, and I value all the lessons that
he has taught me in the past and the ones that he will teach
me in the future.
Now I've only known Bob Morrison for a short time, But I
have to tell you that being that he was a former Marine
hero, I knew that I would like him before I even met him.
And it felt right from the day we walked into the same room
together. And it's certainly proven out by the events that
led up to today.
He's committed to his company, his shareholders and his
people. He's open and candid in his style. And he's
passionate about what he does. And I know Bob will be as
good to work with as he was to deal with. And that was
pretty exceptional. And I kept - to say this morning that
I'm as delighted about Indra's promotion as I am about this
transaction overall. Because she is one of the most talented
and deserving leaders that I've even known. She's not only
played a key role in making this combination work, but as
all of you know, she's been instrumental in everything that
we've done over the last five years. And it's been a real
privilege to work alongside her. She's not only very good at
what she does, but she's also a lot of fun.
So sort of in closing, I'd like to reinforce Roger's points
about the tremendous enhancement that this combination
offers to both companies and to our stakeholders, our
customers, our partners, shareholders and all of our
associates.
You know, as I think back, the last time we talked about
something like this, was when we shared the announcement of
the addition of Tropicana to our family. And we were very
optimistic at that time as you can remember, about the
potential. But we never expected that it would turn out as
well as it has. And I believe there are lots of parallels to
what we deal today. We're confident that we will be sitting
here a year from today, and that we will have great...
...our business press or very importantly, Quaker employees,
want everybody to know that I'm personally, absolutely
thrilled with the prospect of combining the Quaker Oats
company with PepsiCo. It's obvious I think, that this merger
is a good thing for Quaker shareholders.
For the three years through October 31 of this year -- and
I'm picking that date because it was just a couple of days
before the takeover rumors hit the press, for that
three-year period, Quaker shareholders had seen an average
annual return of nearly 22% -- a return that as you know,
far out-distanced the performance of any of our food peers
over that period. At Friday's close, we anticipated Pepsi's
deal will provide a premium of nearly 20% on top of the
October 31 price.
So I think clearly, this represents a very attractive
immediate return. But of far greater importance to those
shareholders who have taken a longer term view, I think
there's an opportunity here to participate in one of the
most dramatic growth stories in food and beverage history.
I think everybody's aware that in recent times, mergers in
our industry or others, often bring together one struggling
company with another, or at best, one struggling company
with one who is doing well. This merger is really unusual in
that respect. It's combining two companies that are both
firing on all cylinders, leading their industries in every
respect, combining two companies each with highly respected
management teams.
This combination presents the prospect of a truly awesome
growth story and therefore very impressive future returns
for our Pepsi-shareholders over time.
I just want to say that I think this merger is also good for
our employees at Quaker. Quaker employees I think, have
proven that they're winners. This merger will provide them
with a very significant increase in the resources available
to keep on winning in the marketplace. And the merger will
also provide them with an opportunity to grow on a personal
level, in a company long known for identifying and
developing a diverse group of strong leaders.
Our employees, I think are going to thrive in this
environment and will see greater career growth possibilities
than were even possible in a standalone Quaker Oats company.
I'm genuinely excited to join Roger, Steve and Indra as part
of the PepsiCo leadership team. I firmly believe we are
going to do great things together.
Man: Thank you Bob. And at this point, we'd be happy to entertain
any questions.
Operator: Thank you. The question and answer session will be conducted
electronically today. If you would like to ask a question,
please press the star or asterisk key followed by the digit
1 on your telephone. We will proceed in the order that you
signal us and take as many questions as time permits. Once
again, that is star 1 to ask a question.
And our first question comes from (Blaine Marter) of GE
Assessments.
(Blaine Marter): Hi. Do you anticipate reissuing any shares to kind of
conform with pooling criteria?
Man: Indra, do you want to handle that?
Indra Nooyi: Yes, we have to reassure about 20 million shares to cure the
(inaudible).
(Blaine Marter): Okay, and that will be done immediately upon closing?
Indra Nooyi: It'll be done just before closing.
(Blaine Marter): Thank you very much.
Operator: Our next question will come from (Nick Booth) of Wellington
Management.
(Nick Booth): Yes hi there. I've got a question on synergies that may or
may not be in your model. The cold drink channel, any
opportunities there for enhancing Gatorade's position there
with your bottling distribution system?
And then secondly in the international markets where you may
have a particularly strong presence I'm thinking of Mexico,
what are the synergies there that you model into the
projections of forward-looking earnings growth?
Man: Well (Nick), as Roger said, we think that there are
opportunities all over our businesses to add. But we did not
include synergies for either one of the examples that you
mentioned in our model.
(Nick Booth): Okay, thank you.
Operator: Our next question comes from John (Pocker) of JP Morgan.
John (Pocker): Thanks. Just wanted to follow-up on Nick's comment. Can you
compare the Gatorade percentage of volume by distribution
channel specifically? I `m thinking vend in some of these
small format stores where you've said it's underdeveloped?
Can you compare Gatorade's percentage of volume through
those channels to sort of your standard CFD lines?
Man: I might ask if Sue Wellington in Chicago who leads the
Gatorade business would answer that question.
Sue Wellington: Sure, hello. Hi, it's Sue. About 90% of the Gatorade
business in the United States is through what Roger would
have described as either large format or chain convenience
store, drug, mass merchant club business. We have a
relatively small on-premise business that is very, as you
know, targeted to points of sweat to be under 10% of our
business.
And I would echo although it's not modeled, that there
certainly is an opportunity for us to expand our view of
on-premise and specifically go after the vend opportunity
again, although it's not in any of the numbers you just
heard.
Man: So that 10%, would that include sort of the mom and pop
(bodegas) type of volume? Or would that be mostly - would
that be in the 90%?
Sue Wellington: It'd be in the 90%. And that's really less than 2% of the
90%.
Man: Great thanks.
Operator: And we'll go next to Andrew (Conway) of Morgan Stanley.
Andrew (Conway): Thank you operator. A couple of brief questions. Indra, in
your modeling, if you could give an idea in terms of your
base case revenue and EBIT growth in the non-snack food
business, talk a little bit about, Steve perhaps, when
you've looked at the non-food business, or Roger, the
opportunities you see going forward in revenue opportunity?
And finally, comparing the (tress), a little bit of the
capital intensity in both businesses please?
Indra Nooyi: Andrew, let me just talk about the non-snack food business
Andrew. What we've modeled in our base case, is 3.3% revenue
growth going forward and 4-1/2% EBIT growth going forward.
And as Roger mentioned to you, on Gatorade we have modeled
9.4% revenue growth and 13-1/2% EBIT growth. This does not
include any of the synergies.
And on the snack side, we've included 8% revenue growth and
10.8% EBIT growth. This is again, Quaker standalone base
case. And if you total all these together, we have a base
case Quaker of 6.4% revenue growth and 8.7% EBIT growth
between the years 2000 and 2005.
Man: Andrew, to the second question, as Roger said, we think that
this opportunity to take the Quaker legitimacy and the snack
brands that they already have and the extensions to that
into the Frito system is an enormous upside. We have
obviously accelerated the growth from the current business
because of that. But frankly the upside to that is what
makes us all very optimistic about the combination.
Operator: Anything further Mr. (Conway)?
Andrew (Conway): Just a comparison if Indra would provide a view as to the
capital intensity please of Quaker versus Pepsi as revenues
should grow faster than capital spending. Are they taking
into account the high single volume growth of the Gatorade
brand?
Indra Nooyi: Let's just talk about capital. As again, Roger mentioned in
his opening comments Andrew, PepsiCo standalone today is
about 5-1/2% capital expenditures percentage of sales. And
Quaker has a higher cap ex as a percentage of sales this
year.
The combination, just a simple summation, gets us to 5-1/2%.
What we've done in our modeling is looked forward and
adjusted for this unusually high capital expenditure that
Quaker has this year and looked at our own plan. And
excluding any acquisition related cap ex, and including all
the costs - I mean the topline synergies that come into the
model, this capital expenditure as a percentage of sales
comes down to 4-1/2%.
And again, as we mentioned to you earlier, this number does
not include any cap ex that we might avoid because of all
the supply chain rationalization opportunities available to
us, nor does it include a reduction in the cost of capital
equipment procured because of the additional scale that
PepsiCo brings to Quaker.
So we still have to go kick the tires and the number. But
for the sake of modeling today, again staying with this
whole thing of conservatism, my suggestion is between now
and 2005, you draft this 5.5% number down to 4-1/2%.
Andrew (Conway): Thank you.
Operator: And our next question today comes from David Nelson of CS
First Boston.
Mr. Nelson, please go ahead. Your line is open. Without
hearing response sir, I would like to move on to (Jennifer)
Salomon of Salomon Smith Barney.
(Jennifer) Salomon: Thanks so much. I just want to make sure that I've got this
correct numbers for the synergies. You talked about 65
million of cost savings for (Panilli) for rationalization of
hot sell on the beverage side. What about any kind of cost
savings purchasing leverage on the domestic food side? Do
you see really much opportunity there? Do you want to give
us any kind of number at this point?
Man: Jennifer, let me take this - Roger. Let me take that one
because I also understood that I transposed a number during
my presentation. So I'll just take you down quickly again
through the synergies trip from the standpoint of the
pre-tax operating impact going out to year five.
As I said, they were $230 million. Forty-five million of the
230 comes from the improvement in Tropicana ambient sales in
the - essentially in the Gatorade Quaker system. Thirty-four
million dollars of the opportunity comes from the
improvement in Quaker snack sales in the Frito-Lay system.
Sixty million dollars comes from procurement which is the
question you had just raised to $60 million by year five.
While I said that, I ascribed that all to beverages. In
fact, that is all across the Quaker product line. And it's
other goods and services. It's everything. Now frankly our
purchasing people think that is extraordinarily conservative
number. And we're going to count on them proving us wrong.
That is, proving themselves right that this very
conservative.
And then the next one was this - the whole question of
Tropicana and Pepsi-Cola non-carbs and Gatorade with the hot
fill production, the warehousing, the - all that sort of
supply chain go-to-market capability. That was $65 million.
And then finally by year five, we'd have 26 million of
savings of corporate and other. So that's the way the 230
shakes out.
Jennifer Salomon: Thank you.
Operator: And from AG Edwards, (Timothy Swanson) has our next
question.
(Timothy Swanson): Yes, good morning everyone. You clearly pointed out what
happens in year five as well as what happens in year one. My
question is more so if you were to take a look at what your
baseline is and you have a target of the 13% to 14%, how
does year two through four relate to that 13% to 14%? And is
there enough leverage in the tax rate as well as the - some
other non-operating issues to reach that target in the first
maybe two - or three year?
Indra Nooyi: Let me just say that one of the - the reason we've modeled
this combination with PepsiCo is that in no year do we move
away from our stated topline, EBIT or earnings per share
growth. In absolutely no year between the first year of the
deal and the fifth year of the deal.
Rather than walk you through the assumptions year by year,
why don't we do that off-line to the extent that we can. But
what you should assume is stay within those financial guides
we have committed to you, and then work backwards from that,
counting in the synergies on the schedule that we've just
given you.
(Timothy Swanson): Okay, so really you are holding yourself to 13% to 14%
earnings per share growth in year two through year five?
Indra Nooyi: Year two - the first full year after the merger, you've got
to be very careful about the calanderization of the merger.
So it's not just in a fiscal year two which would be 2002.
But it would be the second full year after the merger. So
that's the way you should work in the numbers.
But yes, if we ramp up closer, you know, to 13% in the first
year and then slowly work up, you know, to the higher
number, closer to 14, but, it's that range of 13 to 14.
Man: Okay, thank you.
Operator: And we'll go next to (John McMillian) of Prudential
Securities.
(John McMillian): Good morning everybody. Bob, on behalf of Quaker
shareholders, good job. So now you can drink soft drinks at
your desk without feeling guilty. You always used to amaze
me watching you drink...
Man: Never mind.
(John McMillian): I won't mention it was a toast. Just - this deal sounds
great for Pepsi. But just taking the Devil's advocate point
of view for a second, let's just assume Pepsi's stock in a
weak market goes down to 36, 37. Sorry for the background
noise. What - basically, I'm just trying to get what kind of
protection's going to be made Bob, in terms of your
willingness one to walk, and Pepsi's willingness to kind of
make us whole at 92. Can you just kind of walk through that
scenario and make a guess of what happens?
Bob: Yes, that's the kind of hypothetical question that's very
very difficult to deal with because I would be flabbergasted
with the story we've got here if the stock ever got to 40 or
below 40. So I think that's something that I think it's an
academic question we're never going to have to deal with.
But I appreciate the question John.
(John McMillian): I hope you're right.
Bob: So do I.
(John McMillian): That must mean you have been. My only comment to the numbers
which appear conservative but, you know, Bob, if you're - if
this non-snack food business can do 3.3% sales, I want to do
a lot more than 4-1/2% earnings. Is anything - my only
comment to the (plaker) numbers is the sales goal that
appeared to be a little bit high in relation to the earnings
goal for the non-snacks business, am I missing something...
cereal margin compression of whatever you're assuming?
Bob: Yes, I wouldn't read too much into that. As you know, our
board's approved this on Saturday. We were not part of all
the discussion on it. I will tell you that everything that
Pepsi used in modeling it was based on numbers that we
provided them during due diligence.
I'll tell you that without question, we would - our whole
management team would stand behind all of the total
assumptions used in this total model that they've got from
the standpoint of revenue growth and profit growth. If
you're asking me, do I hold my people to higher EBIT growth
on the food business knowing we've got all this cost savings
coming out from the restructuring -- and we told you about
that absolutely -- but I think the totals that we're looking
at which were what - in six and nearly nine, are very
consistent with our numbers and very consistent with
everything I've always told you - told the analysts and the
investors.
(John McMillian): Okay, well congratulations.
Bob: Thank you.
Operator: And from UBS Warburg, (Carolyn Levy) has our next question.
(Carolyn Levy): Good morning everybody, couple of questions. One, why will a
deal take so long to close? You know, are you being very
conservative in thinking around April or, you know, if you
could just run us through that a little bit?
And secondly, if we could just touch on what the pricing
assumptions are for Gatorade going forward?
Man: (Carolyn), let me ask our General Counsel Rob (Sharp), to
field your first question.
Rob (Sharp): (Carolyn), I think in this day and age with the
unpredictability of what comes out of Washington and how
long regulatory approvals take, we're planning this to be
conservative. We really think we have a great story to tell
from a regulatory standpoint. And I'm hopeful we can get
through it sooner than that.
But just for our modeling purposes, consistent with
everything else we've done in the model, we're trying to be
conservative.
(Carolyn Levy): Okay. And on the pricing for Gatorade?
Indra Nooyi: Be more specific (Carolyn) if you must - if you may.
(Carolyn Levy): Just of the 9% revenue growth or 9-1/2% in Gatorade, how
does this break out volume and pricing?
Man: We really can't talk about forward-looking pricing. It would
not be good competitively for us to do that. What I'll tell
you is very basically, these numbers are consistent with our
numbers and are not really driven by pricing. I think I can
tell you that.
(Carolyn Levy): Okay, can I ask for clarification from Roger on one thing?
On free cash flow per share, you mentioned 20 cents a share.
Is that per year?
Roger Enrico: No, that was cumulative over the first five years.
(Carolyn Levy): Okay thanks.
Indra Nooyi: (Carolyn), there's one other point. The Gatorade base case
number is 9.4% revenue and 13-1/2 EBIT is a global Gatorade
number. It's not just a US number. So it's a global Gatorade
number which includes improvement in certain other countries
of the world too.
(Carolyn Levy): Thank you.
Operator: And our next question comes from (Eric Kastner) of Deutsche
Bank.
(Eric Kastner): Hi, good morning. I have two questions. The first is is it
possible given the structure of the deal, that if you got
unsolicited bids for the non-snack business, that
underpooling those could be sold if Quaker had not spoken to
the bidder beforehand? And then second, it would seem to me
from a total Pepsi perspective -- although I'm not a
beverage analyst -- 1% topline growth should generally
translate into much more than 1% EBIT growth. So do you have
more of an optimistic scenario that you could share with us?
Because 1% top to 1% EBIT seems pretty conservative.
Man: (Eric), let me ask Rob to handle your first question.
Rob (Sharp): (Eric), I think within the bounds of (preliminary)
regulations, our basic intention is not to sell these
businesses. I think that consistent with the position on the
accounting, your right the facts and circumstances in
pooling situations can change going on - what goes on in the
future. But any deal that might happen in the future I think
is pure speculation. And I certainly wouldn't assume it. I
think we're very comfortable with the quality of these
businesses in the context of the overall transaction.
Man: And (Eric), in relation to your second question, we've said,
you know, throughout this presentation that we believe our
assumptions are conservative and we certainly would have
internal expectations what would be higher. And I think I'd
leave your question at that in a sense that we today want to
stand on the commitments that we make conservative as they
are.
(Eric Kastner): Okay thank you.
Operator: And we'll move next to (Ann Gerten) of Davenport
Incorporated.
(Ann Gerten): Good morning, congratulations everybody.
Man: Thank you.
(Ann Gerten): One question you touched a little bit abut your goal and
(FruitWorks). Any changes to the launching of those
products, timing of those products, support behind those
products -- anything like that?
Man: No changes. As you know, (FruitWorks) is in the market. They
have been very successful this year, exceeded our
expectations quite frankly. And Dole is on track to -
actually almost as we speak to be in the marketplace.
(Ann Gerten): Great, thank you.
Operator: And we'll go next to (Manny Goldman) of ING Barings.
(Manny Goldman): Good morning everyone. Just a couple of questions if I may.
First one, with the non-carbonated drinks business and the
US strengthening so significantly over the last couple of
months including this transaction, what would you look for
over the next several years in terms of US soft drink unit
volume growth rate?
And the second thing, totally different. In the
international business, could you comment on the energy bar
business and what exists outside of the US and the potential
let's say over the next several years?
Man: On your first question (Manny), I think Roger alluded to it
in his opening comments that we think that that carbonated
beverage piece of US business will probably grow in the 2%
to 3% range -- somewhere in that neighborhood. And I think
that's really what we said all along. And we don't see any
major changes to that at this point.
On your second question, the energy bar business outside the
United States we think is a big upside. It is not very well
developed. Quite frankly, there's probably a lot of
development yet to be in the United States but certainly
upside. And we think with our distribution business it's
quite a good fit.
Man: And I would add (Manny), on the US beverage business, if we
think about carbs as you said and then we talked about the
non-carbs, since the non-carbonated business category, the
market if you will, is drawing about 9. And if we take the
broadest interpretation of non-carb that I talked about
earlier in the presentation which would include the juice
businesses from Tropicana, both chilled and the ambient, and
then the non-carbs that Pepsi-Cola already has in the
Aquafina and so on, and then kind of loop Gatorade into that
just for the arithmetic of this whole discussion, you know,
obviously we would have a non-carb portfolio that is growing
faster than the total carbonated market. And we would have a
much higher percentage of the mix of our present - and we
presently do. Because Tropicana pure premium is growing high
single digit real growth. And at Gatorade we expect high
single digit revenue growth. You know what Aquafina and the
rest of these are doing.
So we're going to see if you think about our beverage
portfolio and that sort of universal kind of look at it,
you're going to see a step-up that's fairly significant in
our US volume growth rates.
(Manny Goldman): So a 2% to 3% number would probably - under those
theoretical assumptions anyway could very well be too low.
Man: Well 2% to 3% on the carb side I think is probably not -
that's probably reasonable. But if you can add non-carb into
it it's going to be much higher than that.
(Manny Goldman): Got you. Okay, thanks very much.
Operator: From Prudential Securities, George Thompson has our next
question.
(George Thompson): Good morning.
Man: Good morning George.
(George Thompson): Steve, maybe you could answer this question. It seems to me
that when you look at the beverage business, what Pepsi
brings to the table here are higher margin channel mix. And
I'm wondering how you work that into the 9-1/2% growth
number?
And the second thing that I'm wondering about is the
promotional levels on Tropicana. Typically the promotional
expenditures on - or not Tropicana, excuse me, Gatorade, are
typically the promotional spending on a Gatorade even close
to what they are maybe on a Pepsi or the carbonated soft
drink business in general?
Steve Reinemund: George, on your first question, I'm not sure what you're
actually asking. I think that Roger just sort of amplified
the growth rates that we're looking at.
Roger Enrico: Yes, I think George that the 9.4% Gatorade revenue growth
assumes zero benefit -- none -- from any combination with
PepsiCo. So those benefits that you and I could quite easily
articulate are upsides to this model. And we've just not
worked any numbers in - through we do believe there are
going to be some benefits. And we've not included any
numbers either domestically or internationally. So 9.4 if
you will, revenue growth from Gatorade is the base case.
(George Thompson): I guess my question through is how significant could that
be, mix change?
Roger Enrico: Well some people have modeled up to a 10% increased in sales
from this kind of synergy. You know, frankly, I haven't
struck all those numbers yet myself and I don't know okay,
nothing that I'd be comfortable sharing with you today.
(George Thompson): Okay.
Man: On your second question, Sue would you try to handle that
one?
Sue Wellington: Excuse me, can I get the question again?
Man: Go ahead Steve.
Steve Reinemund: Go ahead and restate it George.
Sue Wellington: In terms of the trade expense?
Steve Reinemund: Yes, right.
Sue Wellington: I - rather than talking specifically because I think it's
getting into a price discussion, I would just... in with the
warehouse delivered beverage. And it was probably more in
line with Tropicana ambient business then they are in the
Pepsi-Cola refreshment business.
To be fair, it's almost an irrelevant comparison because as
Roger has stated, in the grocery, large format chain
convenience store chain drug, chain mass merchant et cetera
business, it's the intention to keep those businesses
warehouse delivered and operating very similar to where they
are today.
(George Thompson): From the promotional spending in the mom and pop side of the
business is minimal. Is that correct?
Sue Wellington: If they are a mom and pop business period it is relatively
small. Certainly the financial investment would also be.
(George Thompson): Okay, fine. Thank you.
Operator: And we do have time for two more questions at this point. I
will go ahead and more our next question to Mark (Cowan) of
Goldman Sachs.
Mark (Cowan): Good morning. I'm not sure who wants to field this. But I
was wondering if you might bring a little more life to this
opportunity in the new grocery aisle for beverages. You
talked about 400 million increased Tropicana sales. And I
wonder if you can just give us better perspective or more
perspective on what the key segments of this, you know,
newer area that you're talking about really are in your
mind, how Pepsi's products really are lining up, you know,
where you see the business headed and what the competencies
that you have really to leverage as you look at this area
are?
Man: Let me make a comment there and let Roger and Bob give their
thoughts. But right now, between Gatorade and Tropicana as
it exists, we have a pretty significant presence there. But
we think from the sales side, from the product development
side, from the manufacturing and procurement side, there's
just an enormous amount of synergy that allows us to work
together to really be a leader in this aisle. And I thought
Roger's suggestion of taking a look at this aisle would be
very helpful to you as you try to think through what the
potential upside would be. You only have to walk down the
aisle and imagine what this could be and the leadership that
could be provided here by the scale of these two players.
And frankly, Gatorade has the leading position there today.
And we think that Gatorade can bring an enormous amount of
leadership to the ambient Tropicana business.
Man: Yes Mark, I would add by saying one way to think about this
is just think about these grocery stores and various aisles.
You know, really Tropicana is primarily a chilled-juice
company. And a very high proportion of its total business
really is in one block-buster product, Tropicana Pure
Premium.
So when you think about the chilled section of the store
where these products are merchandise, in most parts of the
country and in most accounts, Tropicana is by far the big
gut-- fastest turns, the highest profits, the greatest
(honest) stocks I might add okay, in the grocer's offerings.
And so it's natural that Tropicana is looked to by our
retail customers to be the category capped people they would
expect to bring the best insight on how to manage that
section to the customer's benefit -- to the greatest
customer benefit.
Now we walked down the soft drink aisle of the store. Now
clearly now that's a (DSD) aisle okay. And, you know,
certainly we've got a pretty significant competitor there. I
wouldn't suggest that we didn't. But nonetheless, Pepsi-Cola
in more cases than anyone else is selected to be the
category captive for the soft drink aisle, presumably
because our folks are pretty good at brining the insight to
the customer as to how to optimize his returns and his
sales.
Needless to say, when we go down the snack food aisle,
Frito-Lay is by far the preferred partner of the retail
customers out there and has done a really superb job in
optimizing the retailer sales and profits and profit growth
from snack foods.
Now we have the opportunity to go down a fourth aisle, an
aisle in which we presently participate in only a very
modest way with Tropicana Twister and a few other products,
an aisle that is highly fragmented, an aisle that from a
large format standpoint represents - is the representation
of the larger category of $7-1/2 billion, and an aisle in
which Gatorade really has the biggest share of anything sold
in that aisle -- about 10%.
And what we expect to be able to do now is what we've done
in these other three aisles that I've just described, is be
able to bring the insights to our retail customers that
would allow us to improve our position in that category.
Now I'm not suggesting this is only all about insights and
category management. Right along with that, we would expect
more product innovation, more product news, more package
news -- you name it -- all the things that come together to
build the growing and healthier business.
So that's kind of the way we look at it. And frankly, one
way to think about this is that while we've all thought
about a lot and modeled in our own minds maybe, what
PepsiCo's stored or distribution system, both PepsiCo
beverage and snack could bring to the Quaker portfolio, what
we're suggesting is of equal importance is something that we
should give as much thought to is what - Quaker very capable
warehouse selling and go-to-market system can bring to the
PepsiCo portfolio.
And in fact we see very hard synergies coming from that. And
it now gives us the scale that Tropicana alone does not have
to be able to be a premier warehouse delivery partner to our
customers as well as a premier stored (order) partner.
Mark (Cowan): Thank you.
Operator: And our final question today comes from Doug Lane of Merrill
Lynch.
Doug Lane: Yes, good morning everybody. First, to follow on Mark's
question, I assume that aisle that you're talking about
Roger, there's nobody really that have category management.
I mean how is that aisle being run now? So can you just put
some color on that? So I think just adding a category
manager in general would be viewed as a positive there.
And then this is an expertise, obviously your DSD side has.
Will this be managed in conjunction with the Pepsi-Cola
system or independently? And then a couple other questions.
You talked about the hot fill capabilities that go along
with the manufacture of the functional beverages. Can you
just drill down a little bit on what kind of hot fill
capabilities the combined Tropicana and Gatorade has and
Pepsi-Cola with co-packers and whatever and how that
compares to competitors and what really logistical
opportunities there are there?
And then my last question is - deals with a specific channel
with the convenience channel. It seems to me that with the
combination of Gatorade and the PepsiCo brand, that you're
going to have an awfully large presence in the convenience
stores. So can you elaborate on the health of the
convenience channel, both pricing and volume growth and then
how you plan to continue to gain share there?
Man: Okay, that's a big order but let me give it a shot. On the
first question with respect to category management of the
aisle I described, given the way I described the aisle --
and not to sound factious -- if there is anyone of those
category managers I don't think they'll admit it. So I would
say that is not a - it is not an aisle that has had the
benefits of category management.
Now with respect to where we'll get that capability if you
will for category managing that aisle, I think first off I'd
say that the Quaker sales organization is certainly quite
familiar with the category management techniques and the
State of the Art know-how how to do that.
And obviously they would get all the assistance that PepsiCo
can provide which includes by the way, a power one center
that we have out of Dallas that specifically does highly
sophisticated research and analyticals on category
management on the categories we work. So obviously they'll
be able to tap into that whole capability that we have.
Now, on the hot fill thing, I'm going to come up short on
that one because that's a whole lot more than I am confident
that I know. I may think I know some of it, but I'm not sure
I actually do.
I would say that the combination of all of these, we believe
would make us by far the largest hot fill manufacturer in
the United States. Some of our hot fill right now is done
co-packed. Some of it is - and when I say our, I mean the
combined companies now. A good deal of it is done in-house.
And point in fact, in the Pepsi system, there are some
underutilized hot fill facilities where we hot fill Lipton
Tea and frapaccino. And as you know, the Lipton tea business
has moved more toward brisk which is a cold filled product.
So we have some additional capacity within the Pepsi system
that also can be utilized. Then of course Tropicana's
ambient products are hot filled.
So all of this in combination along with the warehousing and
over-the-road delivery type logistics costs related not too
much now to the Pepsi system but to the total Tropicana
business chilled and ambient and the Gatorade business,
that's where we see getting the 65 million by year five of
pre-tax saves.
And your final point on convenience stores, clearly this -
we're already an extraordinary important supplier to
convenience stores. As you know, as measured by IRI, we are
- Pepsi-Cola is the leading supplier in the refreshment
beverage business to convenience stores. Added to that, we
have a small but pretty nicely growing now, business with
Tropicana in convenience stores. And as you well know,
Gatorade has a very successful and highly developed
convenience store business.
And I have no doubt that we're going to see some
opportunities going forward to make all of that more
efficient and more effective -- nothing we've modeled into
our combination models again. But I would expect that that
business would continue to be, if not an accelerating - and
excellent source of growth if not an accelerating source of
sales and profit growth for the combined companies.
Doug Lane: I assume that channel still is among the more rapidly
growing distribution channels, the convenience?
Man: Yes. Yes, that's correct. And not only distribution, but on
same store sales growth because you're just getting a lot of
sales growth out of this channel on beverages as people move
to these single serve and cold bottle as opposed to simple
the take home business.
Doug Lane: And just finally Roger, I appreciate the response, but in
trying to put convenience in perspective, do you have what
percentage of PepsiCo. And let's include Frito-Lay in there
as well is - of the convenience channel or vice-versa what
the convenience channel is of the combined PepsiCo here. Do
you have those?
Roger Enrico: Well I'll tell you, rather than give you an off-the-top head
answer which is probably wrong given I've got about 400,000
numbers I my head and that's not one of them right now - let
us - we'll go off-line and get you that answer
Doug Lane: Okay.
Roger Enrico: Of course we can get the number for you.
Doug Lane: Okay, thank you.
Operator: That concludes today's question and answer session. At this
time, I would like to turn the call back over to Kathleen
Luke for closing remarks.
Kathleen Luke: I just wanted to thank everybody for joining us today. A
couple housekeeping matters for just a second.
First, we really want to apologize to those who are on the
Web site. Apparently we understand there were some slide
shows that were (inaudible). And I guess due to the high
level of interest, the server went down in the middle. But
the entire Web cast will be available for replay on our Web
site which is www.PepsiCo.com. The audio portion on the Web
site will be available by noon. And the complete audio and
slide show together will be posted by the end of the day.
We also have the call recorded. And it's available for
playback on the phone by dialing in the US, 888-203-1112.
And if you're outside of the US, you can dial in at
719-457-0820. And in either case, you should use the
reservation number 496950. And that playback will be
available commencing at noon today and will be available
through 5 o'clock on Friday.
So thank you all for joining us and we'll talk to you
another time.
Operator: And that concludes today's conference. Thank you for
choosing Premiere conferencing.
END
