10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

 

    x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 27, 2014

OR

 

    ¨ 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 1-4171

KELLOGG COMPANY

 

State of Incorporation—Delaware    IRS Employer Identification No.38-0710690

One Kellogg Square, P.O. Box 3599, Battle Creek, MI 49016-3599

Registrant’s telephone number: 269-961-2000

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 such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or shorter period that the registrant was required to submit and post such files).

Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x   Accelerated filer  ¨   Non-accelerated filer  ¨   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  x

Common Stock outstanding as of October 25, 2014 — 355,033,895 shares

 

 

 


Table of Contents

KELLOGG COMPANY

INDEX

 

     Page  

PART I — Financial Information

  

Item 1:

  

Financial Statements

  

Consolidated Balance Sheet — September 27, 2014 and December 28, 2013

     3   

Consolidated Statement of Income — quarter and year-to-date periods ended September  27, 2014 and September 28, 2013

     4   

Consolidated Statement of Comprehensive Income – quarter and year-to-date periods ended September  27, 2014 and September 28, 2013

     5   

Consolidated Statement of Equity — year ended December  28, 2013 and year-to-date period ended September 27, 2014

     6   

Consolidated Statement of Cash Flows — year-to-date periods ended September 27, 2014 and September  28, 2013

     7   

Notes to Consolidated Financial Statements

     8   

Item 2:

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     27   

Item 3:

  

Quantitative and Qualitative Disclosures about Market Risk

     43   

Item 4:

  

Controls and Procedures

     44   

PART II — Other Information

  

Item 1A:

  

Risk Factors

     45   

Item 2:

  

Unregistered Sales of Equity Securities and Use of Proceeds

     45   

Item 6:

  

Exhibits

     45   

Signatures

     46   

Exhibit Index

     47   


Table of Contents

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED BALANCE SHEET

(millions, except per share data)

 

     

September 27,
2014

(unaudited)

    December 28,
2013 *
 

Current assets

    

Cash and cash equivalents

   $ 426     $ 273  

Accounts receivable, net

     1,565       1,424  

Inventories:

    

Raw materials and supplies

     348       319  

Finished goods and materials in process

     860       929  

Deferred income taxes

     207       195  

Other prepaid assets

     166       127  

Total current assets

     3,572       3,267  

Property, net of accumulated depreciation of $5,717 and $5,501

     3,790       3,856  

Goodwill

     5,021       5,051  

Other intangibles, net of accumulated amortization of $40 and $34

     2,327       2,367  

Pension

     512       419  

Other assets

     550       514  
                  

Total assets

   $ 15,772     $ 15,474  
                  
                  

Current liabilities

    

Current maturities of long-term debt

   $ 607     $ 289  

Notes payable

     1,079       739  

Accounts payable

     1,466       1,432  

Accrued advertising and promotion

     497       476  

Accrued income taxes

     56       69  

Accrued salaries and wages

     293       327  

Other current liabilities

     664       503  
                  

Total current liabilities

     4,662       3,835  

Long-term debt

     5,963       6,330  

Deferred income taxes

     943       928  

Pension liability

     267       277  

Nonpension postretirement benefits

     62       68  

Other liabilities

     430       429  

Commitments and contingencies

    

Equity

    

Common stock, $.25 par value

     105       105  

Capital in excess of par value

     656       626  

Retained earnings

     7,161       6,749  

Treasury stock, at cost

     (3,523     (2,999

Accumulated other comprehensive income (loss)

     (1,016     (936
                  

Total Kellogg Company equity

     3,383       3,545  

Noncontrolling interests

     62       62  

Total equity

     3,445       3,607  

Total liabilities and equity

   $ 15,772     $ 15,474  
                  
                  

 

* Condensed from audited financial statements.

Refer to Notes to Consolidated Financial Statements.

 

 

3


Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME

(millions, except per share data)

 

     Quarter ended      Year-to-date period ended  
     September 27,      September 28,      September 27,      September 28,  
(Results are unaudited)    2014      2013      2014      2013  

Net sales

   $ 3,639      $ 3,716      $ 11,066      $ 11,291  

Cost of goods sold

     2,347        2,266        6,859        6,971  

Selling, general and administrative expense

     927        946        2,761        2,743  

Operating profit

     365        504        1,446        1,577  

Interest expense

     54        56        156        177  

Other income (expense), net

     1        4        14        (8)   

Income before income taxes

     312        452        1,304        1,392  

Income taxes

     86        124        373        398  

Earnings (loss) from joint ventures

     (1)         (2)         (5)         (5)   
                                     

Net income

   $ 225      $ 326      $ 926      $ 989  
                                     

Net income (loss) attributable to noncontrolling interests

     1        —          1        —    
                                     

Net income attributable to Kellogg Company

   $ 224      $ 326      $ 925      $ 989  
                                     
                                     

Per share amounts:

           

Basic

   $ 0.63      $ 0.90      $ 2.58      $ 2.72  

Diluted

   $ 0.62      $ 0.90      $ 2.56      $ 2.70  

Dividends per share

   $ 0.49      $ 0.46      $ 1.41      $ 1.34  
                                     

Average shares outstanding:

           

Basic

     358        362        359        363  
                                     

Diluted

     360        364        361        366  
                                     

Actual shares outstanding at period end

           355        362  
                                     
                                     

Refer to Notes to Consolidated Financial Statements.

 

4


Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(millions)

 

    Quarter ended September 27, 2014     Year-to-date period ended  September 27, 2014  
(Results are unaudited)   Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
   

Pre-tax

amount

   

Tax (expense)

benefit

   

After-tax

amount

 

 

   

 

 

 

Net income

      $ 225         $ 926  

Other comprehensive income (loss):

           

Foreign currency translation adjustments

  $ (87   $ (17     (104   $ (54   $ (17     (71

Cash flow hedges:

           

Unrealized gain (loss) on cash flow hedges

    (2     4       2       (26     11       (15

Reclassification to net income

    —         —         —         (11     3       (8

Postretirement and postemployment benefits:

           

Amounts arising during the period:

           

Prior service credit (cost)

    19       (7     12       10       (4     6  

Reclassification to net income:

           

Net experience loss

    1       —         1       3       —         3  

Prior service cost

    2       (1     1       8       (3     5  

 

   

 

 

 

Other comprehensive income (loss)

  $ (67   $ (21   $ (88   $ (70   $ (10   $ (80

 

   

 

 

 

Comprehensive income

      $ 137         $ 846  

 

   

 

 

 

 

   

 

 

 
    Quarter ended September 28, 2013     Year-to-date period ended  September 28, 2013  
(Results are unaudited)   Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
   

Pre-tax

amount

   

Tax (expense)

benefit

   

After-tax

amount

 

 

   

 

 

 

Net income

      $ 326         $ 989  

Other comprehensive income (loss):

           

Foreign currency translation adjustments

  $ 63     $  —         63     $ (28   $  —         (28

Cash flow hedges:

           

Unrealized gain (loss) on cash flow hedges

    (7     3       (4     5       —         5  

Reclassification to net income

    (2     —         (2     (4     —         (4

Postretirement and postemployment benefits:

           

Amounts arising during the period:

        —           

Prior service credit (cost)

    (1     —         (1     (1     —         (1

Reclassification to net income:

           

Net experience loss

    1       —         1       4       —         4  

Prior service cost

    4       (1     3       10       (3     7  

 

   

 

 

 

Other comprehensive income (loss)

  $ 58     $ 2     $ 60     $ (14   $ (3   $ (17

 

   

 

 

 

Comprehensive income

      $ 386         $ 972  

 

   

 

 

 

 

   

 

 

 

Refer to Notes to Consolidated Financial Statements.

 

5


Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF EQUITY

(millions)

 

   

 

Common stock

   

Capital in

excess of

par value

   

Retained

earnings

   

 

Treasury stock

   

Accumulated

other

comprehensive

income (loss)

   

Total Kellogg

Company

equity

   

Non-

controlling

interests

   

Total

equity

   

Total

comprehensive

income (loss)

 
(unaudited)   shares     amount         shares     amount            

Balance, December 29, 2012

    420     $ 105     $ 573     $ 5,615       58     $ (2,943   $ (946   $ 2,404     $ 61     $ 2,465          

Common stock repurchases

            9       (544       (544       (544  

Net income

          1,807             1,807       1       1,808     $ 1,808  

Dividends

          (653           (653       (653  

Other comprehensive loss

                10       10         10       10  

Stock compensation

        28               28         28    

Stock options exercised and other

        25       (20     (10     488         493         493    
                                                                                         

Balance, December 28, 2013

    420     $ 105     $ 626     $ 6,749       57     $ (2,999   $ (936   $ 3,545     $ 62     $ 3,607     $ 1,818  

Common stock repurchases

            11       (690       (690       (690  

Net income

          925             925       1       926       926  

Dividends

          (505           (505     (1     (506  

Other comprehensive income

                (80     (80       (80     (80

Stock compensation

        21               21         21    

Stock options exercised and other

        9       (8     (3     166         167         167    
                                                                                         

Balance, September 27, 2014

    420     $ 105     $ 656     $ 7,161       65     $ (3,523   $ (1,016   $ 3,383     $ 62     $ 3,445     $ 846  
                                                                                         
                                                                                         

Refer to Notes to Consolidated Financial Statements.

 

6


Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS

(millions)

 

     Year-to-date period ended  
     September 27,     September 28,  
(unaudited)    2014     2013  

Operating activities

  

 

Net income

   $ 926     $ 989  

Adjustments to reconcile net income to operating cash flows:

    

Depreciation and amortization

     375       340  

Postretirement benefit plan expense (benefit)

     (73     (10

Deferred income taxes

     2       (27

Other

     —          73  

Postretirement benefit plan contributions

     (44     (42

Changes in operating assets and liabilities, net of acquisitions:

    

Trade receivables

     (122     (113

Inventories

     40       52  

Accounts payable

     34       (2

Accrued income taxes

     19       52  

Accrued interest expense

     48       33  

Accrued and prepaid advertising, promotion and trade allowances

     10       (4

Accrued salaries and wages

     (33     (9

All other current assets and liabilities

     (5     57  
                  

Net cash provided by (used in) operating activities

     1,177       1,389  
                  

Investing activities

    

Additions to properties

     (355     (363

Other

     7       (1
                  

Net cash provided by (used in) investing activities

     (348     (364
                  

Financing activities

    

Net issuances (reductions) of notes payable

     339       (309

Issuances of long-term debt

     952       645  

Reductions of long-term debt

     (959     (761

Net issuances of common stock

     164       450  

Common stock repurchases

     (690     (544

Cash dividends

     (506     (486

Other

     12       23  
                  

Net cash provided by (used in) financing activities

     (688     (982
                  

Effect of exchange rate changes on cash and cash equivalents

     12       (24
                  

Increase (decrease) in cash and cash equivalents

     153       19  

Cash and cash equivalents at beginning of period

     273       281  
                  

Cash and cash equivalents at end of period

   $ 426     $ 300  
                  
                  

Refer to Notes to Consolidated Financial Statements.

 

7


Table of Contents

Notes to Consolidated Financial Statements

for the quarter ended September 27, 2014 (unaudited)

Note 1 Accounting policies

Basis of presentation

The unaudited interim financial information of Kellogg Company (the Company) included in this report reflects normal recurring adjustments that management believes are necessary for a fair statement of the results of operations, comprehensive income, financial position, equity and cash flows for the periods presented. This interim information should be read in conjunction with the financial statements and accompanying footnotes within the Company’s 2013 Annual Report on Form 10-K.

The condensed balance sheet data at December 28, 2013 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the quarterly period ended September 27, 2014 are not necessarily indicative of the results to be expected for other interim periods or the full year.

Accounts payable

Beginning in 2014, the Company has an agreement with a third party to provide an accounts payable tracking system which facilitates participating suppliers’ ability to monitor, and if elected, sell to designated third-party financial institutions, payment obligations of the Company. Participating suppliers may, at their sole discretion, make offers to sell one or more payment obligations of the Company prior to their scheduled due dates at a discounted price to participating financial institutions. The Company’s goal in entering into this agreement is to capture overall supplier savings, in the form of pricing, payment terms or vendor funding, created by facilitating suppliers’ ability to sell receivables, while providing them with greater working capital flexibility. We have no economic interest in the sale of these suppliers’ receivables and no direct financial relationship with the financial institutions concerning these services. The Company’s obligations to its suppliers, including amounts due and scheduled payment dates, are not impacted by suppliers’ decisions to sell amounts under this arrangement. However, the Company’s right to offset balances due from suppliers against payment obligations is restricted by this agreement for those payment obligations that have been sold by suppliers. As of September 27, 2014, $188 million of the Company’s outstanding payment obligations had been placed in the accounts payable tracking system, and participating suppliers had sold $139 million of those payment obligations to participating financial institutions.

New accounting standards

Presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. In July 2013, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance on financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU is expected to eliminate diversity in practice resulting from lack of previously existing guidance. It applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date. The Company adopted the revised guidance on a prospective basis at the beginning of its 2014 fiscal year, with no significant impact to the Consolidated Financial Statements.

Accounting standards to be adopted in future periods

In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance for accounting for revenue from contracts with customers. The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity would be required to apply the following five steps: 1) identify the contract(s) with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. Entities will have the option to apply the final standard retrospectively or use a modified retrospective method, recognizing the cumulative effect of the ASU in retained earnings at the date of initial application. An entity will not restate prior periods if it uses the modified retrospective method, but will be required to disclose the amount by which each financial statement line item is affected in the current reporting period by the application of the ASU as compared to the guidance in effect prior to the change, as well as reasons for significant

 

8


Table of Contents

changes. The Company will adopt the updated standard in the first quarter of 2017. The Company is currently evaluating the impact that implementing this ASU will have on its financial statements and disclosures, as well as whether it will use the retrospective or modified retrospective method of adoption.

Note 2 Goodwill and other intangible assets

Changes in the carrying amount of goodwill for the year-to-date period ended September 27, 2014, are presented in the following table:

Carrying amount of goodwill

 

(millions)    U.S.
Morning
Foods
     U.S.
Snacks
     U.S.
Specialty
     North
America
Other
    Europe     Latin
America
    Asia
Pacific
    Consoli-
dated
 

December 28, 2013

   $ 133      $ 3,779      $ 82      $ 278     $ 452     $ 89     $ 238     $ 5,051  

Currency translation adjustment

     —           —           —          (2     (26     (1     (1 )     (30

September 27, 2014

   $ 133      $ 3,779      $ 82      $ 276     $ 426     $ 88     $ 237     $ 5,021  
                                                                     
                                                                     

Intangible assets subject to amortization

(millions)

 

Gross carrying amount    U.S.
Morning
Foods
     U.S.
Snacks
    U.S.
Specialty
     North
America
Other
     Europe     Latin
America
     Asia
Pacific
     Consoli-
dated
 

December 28, 2013*

   $ 8      $ 65     $  —        $ 5      $ 42     $ 6      $ 10      $ 136  

Currency translation adjustment

     —          —         —          —          (2     —          —          (2
                                                                       

September 27, 2014

   $ 8      $ 65     $  —        $ 5      $ 40     $ 6      $ 10      $ 134  
                                                                       
                                                                       

Accumulated Amortization

                     
                                                                       

December 28, 2013*

   $ 8      $ 11     $  —        $ 4      $ 4     $ 6      $ 1      $ 34  

Amortization

     —          4       —          —          2       —          —          6  

September 27, 2014

   $ 8      $ 15     $  —        $ 4      $ 6     $ 6      $ 1      $ 40  
                                                                       
                                                                       

Intangible assets subject to amortization, net

                     
                                                                       

December 28, 2013

   $  —        $ 54     $  —        $ 1      $ 38     $  —        $ 9      $ 102  

Currency translation adjustment

     —          —         —          —          (2     —          —          (2

Amortization

     —          (4     —          —          (2     —          —          (6

September 27, 2014

   $  —        $ 50     $  —        $ 1      $ 34     $  —        $ 9      $ 94  
                                                                       
                                                                       

* Certain fully amortized intangible assets which were no longer utilized by the Company have been written off and revised in the prior period presentation. The impact to reporting segments are as follows (millions): U.S. Morning Foods - $20; U.S. Snacks - $5; Europe - $2; and Latin America - $1.

For intangible assets in the preceding table, amortization was $6 million for both the year-to-date periods ended September 27, 2014 and September 28, 2013. The currently estimated aggregate annual amortization expense for full-year 2014 and each of the four succeeding fiscal years is approximately $9 million.

Intangible assets not subject to amortization

 

(millions)    U.S.
Morning
Foods
     U.S.
Snacks
     U.S.
Specialty
     North
America
Other
     Europe     Latin
America
     Asia
Pacific
     Consoli-
dated
 
                                                                        

December 28, 2013

   $ 63      $ 1,625      $  —        $ 95      $ 482     $  —        $  —        $ 2,265  

Currency translation adjustment

     —          —          —          —          (32     —          —          (32
                                                                        

September 27, 2014

   $ 63      $ 1,625      $  —        $ 95      $ 450     $  —        $  —        $ 2,233  
                                                                        
                                                                        

 

9


Table of Contents

Note 3 Restructuring and cost reduction activities

The Company views its continued spending on restructuring and cost reduction activities as part of its ongoing operating principles to provide greater visibility in achieving its long-term profit growth targets. Initiatives undertaken are currently expected to recover cash implementation costs within a five-year period of completion. Upon completion (or as each major stage is completed in the case of multi-year programs), the project begins to deliver cash savings and/or reduced depreciation.

The Company has initiated a number of restructuring and cost reduction activities. The most recent and largest program that is currently active is Project K, a four-year efficiency and effectiveness program announced in November 2013. The program is expected to generate a significant amount of savings that will be invested in key strategic areas of focus for the business. The Company expects that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow.

The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories.

During the quarter ended September 27, 2014, the Company recorded total charges of $92 million across all restructuring and cost reduction activities. The charges were comprised of $64 million being recorded in cost of goods sold (COGS) and $28 million recorded in selling, general and administrative (SGA) expense. During the year-to-date period ended September 27, 2014, the Company recorded total charges of $224 million across all restructuring and cost reduction activities. The charges were comprised of $120 million being recorded in COGS and $104 million recorded in SGA expense.

During the quarter ended September 28, 2013 the Company recorded total charges of $29 million across all restructuring and cost reduction activities. The charges were comprised of $12 million being recorded in COGS and $17 million recorded in SGA expense. During the year-to-date period ended September 28, 2013 the Company recorded total charges of $49 million across all restructuring and cost reduction activities. The charges were comprised of $23 million being recorded in COGS and $26 million recorded in SGA expense.

The tables below provide the details for charges across all restructuring and cost reduction activities incurred during the quarters and year-to-date periods ended September 27, 2014 and September 28, 2013 and program costs to date for programs currently active as of September 27, 2014.

 

    Quarter ended     Year-to-date period ended     Program costs to date  
(millions)   September 27, 2014     September 28, 2013     September 27, 2014     September 28, 2013     September 27, 2014  

Employee related costs

  $ 22     $ 12     $ 74     $ 17     $ 183  

Asset related costs

    6       —         16       5       25  

Asset Impairment

    21       —         21       —         87  

Other costs

    43       17       113       27       163  
                                         

Total

  $ 92     $ 29     $ 224     $ 49     $ 458  
                                         
                                         
    Quarter ended     Year-to-date period ended     Program costs to date  
(millions)   September 27, 2014     September 28, 2013     September 27, 2014     September 28, 2013     September 27, 2014  

U.S. Morning Foods

  $ 15     $ 7     $ 41     $ 12     $ 151  

U.S. Snacks

    32       4       42       10       69  

U.S. Specialty

    1       1       2       3       7  

North America Other

    2       —         11       1       23  

Europe

    23       6       63       6       82  

Latin America

    1       3       6       3       13  

Asia Pacific

    11       1       22       7       46  

Corporate

    7       7       37       7       67  
                                         

Total

  $ 92     $ 29     $ 224     $ 49     $ 458  
                                         
                                         

 

10


Table of Contents

For the quarter and year-to-date periods ended September 27, 2014, and September 28, 2013, employee related costs consist primarily of severance benefits, asset related costs consist primarily of accelerated depreciation, and other costs consist primarily of third-party incremental costs related to the development and implementation of global business capabilities.

The Company currently anticipates that Project K will result in total pre-tax charges, once all phases are approved and implemented, of $1.2 to $1.4 billion, with after-tax cash costs, including incremental capital expenditures, estimated to be $900 million to $1.1 billion. The Company currently expects the charges will consist of asset-related costs totaling $450 to $500 million which will consist primarily of asset impairments, accelerated depreciation and other exit-related costs; employee-related costs totaling $425 to $475 million which will include severance, pension and other termination benefits; and other costs totaling $325 to $425 million which will consist primarily of charges related to the design and implementation of global business capabilities. A significant portion of other costs are the result of the implementation of global business service centers which are intended to simplify and standardize business support processes. Costs incurred to date related to Project K through September 27, 2014 totaled $419 million.

The Company currently expects that total pre-tax charges will impact reportable segments as follows: U.S. Morning Foods (approximately 17%), U.S. Snacks (approximately 10%), U.S. Specialty (approximately 1%), North America Other (approximately 3%), Europe (approximately 12%), Latin America (approximately 3%), Asia-Pacific (approximately 6%), and Corporate (approximately 48%). A majority of the costs impacting Corporate relate to additional initiatives to be executed after 2014 that are currently not fully defined. As the development of these initiatives is completed, the Company will update its estimated costs by reportable segment as needed.

At September 27, 2014 reserves for all restructuring and cost reduction activities are reflected in the table below. A substantial portion of these reserves will be paid out in 2014 and 2015 related to severance payments and other costs.

 

(millions)    Employee
Related
Costs
    Asset
Impairment
    Asset
Related
Costs
    Other
Costs
    Total  

Liability as of December 28, 2013

   $ 66     $  —       $  —       $ 12     $ 78  

2014 restructuring charges

     74       21       16       113       224  

Cash payments

     (40     —         (7     (116     (163

Non-cash charges and other

     12       (21     (9     —         (18
                                          

Liability as of September 27, 2014

   $ 112     $  —       $  —       $ 9     $ 121  
                                          
                                          

Note 4 Equity

Earnings per share

Basic earnings per share is determined by dividing net income attributable to Kellogg Company by the weighted average number of common shares outstanding during the period. Diluted earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares consist principally of employee stock options issued by the Company, and to a lesser extent, certain contingently issuable performance shares. Basic earnings per share is reconciled to diluted earnings per share in the following tables. There were zero and 5 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended September 27, 2014, respectively. There were 6 million and 5 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended September 28, 2013, respectively.

 

11


Table of Contents

Quarters ended September 27, 2014 and September 28, 2013:

 

(millions, except per share data)    Net income
attributable to
Kellogg Company
     Average
shares
outstanding
     Earnings
per share
 

2014

        

Basic

   $ 224        358      $ 0.63  

Dilutive potential common shares

              2        (0.01)   

Diluted

   $ 224        360      $ 0.62  
                            

2013

        

Basic

   $ 326        362      $ 0.90  

Dilutive potential common shares

        2        —     
                            

Diluted

   $ 326        364      $ 0.90  
                            

Year-to-date periods ended September 27, 2014 and September 28, 2013:

 

(millions, except per share data)    Net income
attributable to
Kellogg Company
     Average
shares
outstanding
     Earnings
per share
 

2014

        

Basic

   $ 925        359      $ 2.58  

Dilutive potential common shares

              2        (0.02

Diluted

   $ 925        361      $ 2.56  
                            

2013

        

Basic

   $ 989        363      $ 2.72  

Dilutive potential common shares

        3        (0.02
                            

Diluted

   $ 989        366      $ 2.70  
                            

In February 2014, the Company’s board of directors approved a share repurchase program authorizing the repurchase of up to $1.5 billion of common stock through December 2015. This authorization supersedes the April 2013 authorization and is intended to allow the Company to repurchase shares for general corporate purposes and to offset issuances for employee benefit programs.

During the year-to-date period ended September 27, 2014, the Company repurchased approximately 11 million shares of common stock for a total of $690 million. During the year-to-date period ended September 28, 2013, the Company repurchased approximately 9 million shares of common stock for a total of $544 million.

Comprehensive income

Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by or distributions to shareholders. Other comprehensive income consists of foreign currency translation adjustments, fair value adjustments associated with cash flow hedges and adjustments for net experience losses and prior service cost related to employee benefit plans.

Prior service credits arising during the period resulted from a change in post-retirement benefits provided to certain employees.

 

12


Table of Contents

 

    Quarter ended September 27, 2014     Year-to-date period ended  September 27, 2014  
(millions)   Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
    Pre-tax
amount
    Tax (expense)
benefit
   

After-tax

amount

 

 

   

 

 

 

Net income

      $ 225         $ 926  

Other comprehensive income (loss):

           

Foreign currency translation adjustments

  $ (87)     $ (17)       (104)     $ (54)     $ (17)       (71)  

Cash flow hedges:

           

Unrealized gain (loss) on cash flow hedges

    (2)        4       2        (26)        11       (15)   

Reclassification to net income

    —         —         —         (11)        3       (8)   

Postretirement and postemployment benefits:

           

Amounts arising during the period:

           

Prior service credit (cost)

    19        (7)       12        10        (4)       6   

Reclassification to net income:

           

Net experience loss

    1       —         1       3       —         3  

Prior service cost

    2       (1)        1       8       (3)        5  

 

   

 

 

 

Other comprehensive income (loss)

  $ (67)     $ (21)     $ (88)     $ (70)      $ (10)     $ (80)  

 

   

 

 

 

Comprehensive income

      $ 137         $ 846  

 

   

 

 

 

 

   

 

 

 
    Quarter ended September 28, 2013     Year-to-date period ended  September 28, 2013  
(millions)   Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
    Pre-tax
amount
    Tax (expense)
benefit
   

After-tax

amount

 

 

   

 

 

 

Net income

      $ 326         $ 989  

Other comprehensive income (loss):

           

Foreign currency translation adjustments

  $ 63      $  —         63      $ (28)      $  —         (28)   

Cash flow hedges:

           

Unrealized gain (loss) on cash flow hedges

    (7)       3       (4)       5       —         5  

Reclassification to net income

    (2)        —         (2)        (4)        —         (4)   

Postretirement and postemployment benefits:

           

Amounts arising during the period:

        —           

Prior service credit (cost)

    (1)        —         (1)        (1)        —         (1)   

Reclassification to net income:

           

Net experience loss

    1       —         1       4       —         4  

Prior service cost

    4       (1)        3       10       (3)        7  

 

   

 

 

 

Other comprehensive income (loss)

  $ 58      $ 2      $ 60      $ (14)      $ (3)      $ (17)   

 

   

 

 

 

Comprehensive income

      $ 386         $ 972  

 

   

 

 

 

 

   

 

 

 

 

13


Table of Contents

Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended September 27, 2014 consisted of the following:

 

(millions)                        

Details about AOCI

components

 

Amount reclassified

from AOCI

   

Line item impacted

within Income Statement

    Quarter ended
September 27, 2014
         Year-to-date
period  ended
September 27, 2014
      

(Gain)loss on cash flow hedges:

       

Foreign currency exchange contracts

  $ —          $ (2          COGS

Foreign currency exchange contracts

    (2       (5          SGA

Interest rate contracts

    —           (9          Interest expense

Commodity contracts

    2         5            COGS
                         
  $ —          $ (11          Total before tax
    —            3            Tax (expense) benefit
                         
  $ —          $ (8          Net of tax
                         

Amortization of postretirement and postemployment benefits:

       

Net experience loss

  $ 1       $ 3            See Note 7 for further details

Prior service cost

    2         8            See Note 7 for further details
                         
  $ 3       $ 11            Total before tax
    (1       (3          Tax (expense) benefit
                         
  $ 2       $ 8            Net of tax
                         

Total reclassifications

  $ 2       $ —               Net of tax
                         
                         

Reclassifications out of AOCI for the quarter and year-to-date periods ended September 28, 2013 consisted of the following:

 

(millions)                        

Details about AOCI

components

 

Amount reclassified

from AOCI

   

Line item impacted

within Income Statement

    Quarter ended
September 28, 2013
        

Year-to-date

period ended
September 28, 2013

     

(Gain) loss on cash flow hedges:

       

Foreign currency exchange contracts

  $ (2     $ (7          COGS

Foreign currency exchange contracts

    (1       (1          SGA

Interest rate contracts

    (1       (3          Interest expense

Commodity contracts

    2          7            COGS
                         
  $ (2     $ (4          Total before tax
    —           —              Tax (expense) benefit
                         
  $ (2     $ (4          Net of tax
                         

Amortization of postretirement and postemployment benefits:

       

Net experience loss

  $ 1       $ 4            See Note 7 for further details

Prior service cost

    4         10            See Note 7 for further details
                         
  $ 5       $ 14            Total before tax
    (1       (3          Tax (expense) benefit
                         
  $ 4       $ 11            Net of tax
                         

Total reclassifications

  $ 2       $ 7            Net of tax
                         
                         

 

14


Table of Contents

Accumulated other comprehensive income (loss) as of September 27, 2014 and December 28, 2013 consisted of the following:

 

(millions)    September 27,
2014
    December 28,
2013
 

Foreign currency translation adjustments

   $ (927   $ (856

Cash flow hedges — unrealized net gain (loss)

     (22     1  

Postretirement and postemployment benefits:

    

Net experience loss

     (12     (15

Prior service cost

     (55     (66
                  

Total accumulated other comprehensive income (loss)

   $ (1,016   $ (936
                  
                  

Note 5 Debt

The following table presents the components of notes payable at September 27, 2014 and December 28, 2013:

 

     September 27, 2014     December 28, 2013  
(millions)    Principal
amount
     Effective
interest rate
    Principal
amount
     Effective
interest rate
 

U.S. commercial paper

   $ 644        0.19   $ 249        0.22

Europe commercial paper

     313        0.18       437        0.23  

Bank borrowings

     122          53     
                                    

Total

   $ 1,079        $ 739     
                                    
                                    

In the third quarter of 2014, the Company terminated interest rate swaps with notional amounts totaling $500 million, which were designated as fair value hedges of its 1.875% fixed rate U.S. Dollar Notes due 2016. The interest rate swaps effectively converted the interest rate on the Notes from fixed to variable and the unrealized loss upon termination of $2 million will be amortized to interest expense over the remaining term of the Notes.

In May 2014, the Company issued 500 million (approximately $636 million USD at September 27, 2014, which reflects the discount and translation adjustments) of seven-year 1.75% Euro Notes due 2021, using the proceeds from these Notes for general corporate purposes, which included repayment of a portion of the Company’s commercial paper borrowings. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions, as well as a change of control provision. The Notes were designated as a net investment hedge of the Company’s investment in its Europe subsidiary when issued.

In May 2014, the Company issued Cdn. $300 million (approximately $271 million USD at September 27, 2014, which reflects the discount and translation adjustments) of three-year 2.05% Canadian Dollar Notes due 2017, using the proceeds from these Notes, together with cash on hand, to repay the Company’s Cdn. $300 million, 2.10% Notes due May 22, 2014 at maturity. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions, as well as a change of control provision.

In February 2014, the Company entered into an unsecured Five-Year Credit Agreement to replace its existing unsecured Four-Year Credit Agreement, which would have expired in March 2015. The Five-Year Credit Agreement allows the Company to borrow, on a revolving credit basis, up to $2.0 billion, which includes the ability to obtain letters of credit in an aggregate stated amount not to exceed $75 million and swingline loans in aggregate principal amounts up to $200 million in U.S. dollars and $400 million in Euros. The agreement contains customary covenants and warranties, including specified restrictions on indebtedness, liens and a specified interest coverage ratio. If an event of default occurs, then, to the extent permitted, the administrative agent may terminate the commitments under the credit facility, accelerate any outstanding loans under the agreement, and demand the deposit of cash collateral equal to the lender’s letter of credit exposure plus interest.

In March 2014, the Company redeemed $150 million of its 4.0% U.S. Dollar Notes due 2020, $342 million of its 3.125% U.S. Dollar Debentures due 2022 and $189 million of its 2.75% U.S. Dollar Notes due 2023. In connection with the debt redemption, the Company incurred $1 million of interest expense, offset by $8 million of accelerated gains on interest rate

 

15


Table of Contents

hedges previously recorded in accumulated other comprehensive income, and incurred $5 million of expense, recorded in Other Income, Expense (net), related to acceleration of fees on the redeemed debt and fees related to the tender offer.

The Company has entered into interest rate swaps with notional amounts totaling $2.4 billion, which effectively converts a portion of the associated U.S. Dollar Notes from fixed rate to floating rate obligations. These derivative instruments are designated as fair value hedges. The effective interest rates on debt obligations resulting from the Company’s interest rate swaps as of September 27, 2014 were as follows: (a) seven-year 4.45% U.S. Dollar Notes due 2016 – 3.42%; (b) five-year 1.875% U.S. Dollar Notes due 2016 – 1.58%; (c) five-year 1.75% U.S. Dollar Notes due 2017 - 1.32%; (d) seven-year 3.25% U.S. Dollar Notes due 2018 – 1.84%; (e) ten-year 4.15% U.S. Dollar Notes due 2019 - 2.71%; (f) ten-year 4.00% U.S. Dollar Notes due 2020 - 2.09%; (g) ten-year 3.125% U.S. Dollar Notes due 2022 - 1.32%.

Note 6 Stock compensation

The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, and to a lesser extent, executive performance shares, restricted stock units and restricted stock grants. The Company also sponsors a discounted stock purchase plan in the United States and matching-grant programs in several international locations. Additionally, the Company awards restricted stock to its outside directors. The interim information below should be read in conjunction with the disclosures included within the stock compensation footnote of the Company’s 2013 Annual Report on Form 10-K.

The Company classifies pre-tax stock compensation expense in SGA expense principally within its corporate operations. For the periods presented, compensation expense for all types of equity-based programs and the related income tax benefit recognized were as follows:

 

     Quarter ended      Year-to-date period  ended  
(millions)    September 27,
2014
     September 28,
2013
     September 27,
2014
     September 28,
2013
 

Pre-tax compensation expense

   $ 3      $ 10      $ 31      $ 31  
                                     

Related income tax benefit

   $ 1      $ 4      $ 11      $ 12  
                                     
                                     

As of September 27, 2014, total stock-based compensation cost related to non-vested awards not yet recognized was $51 million and the weighted-average period over which this amount is expected to be recognized was 2 years.

Stock options

During the year-to-date periods ended September 27, 2014 and September 28, 2013, the Company granted non-qualified stock options to eligible employees as presented in the following activity tables. Terms of these grants and the Company’s methods for determining grant-date fair value of the awards were consistent with that described within the stock compensation footnote in the Company’s 2013 Annual Report on Form 10-K.

Year-to-date period ended September 27, 2014:

 

                  Weighted-         
           Weighted-      average      Aggregate  
           average      remaining      intrinsic  
     Shares     exercise      contractual      value  
Employee and director stock options    (millions)     price      term (yrs.)      (millions)  
                                    

Outstanding, beginning of period

     20     $ 54        

Granted

     6       60        

Exercised

     (3     50        

Forfeitures and expirations

     (1     58        
                                    

Outstanding, end of period

     22     $ 56        7.3      $ 132  
                                    

Exercisable, end of period

     11     $ 52        5.8      $ 102  
                                    
                                    

 

16


Table of Contents

Year-to-date period ended September 28, 2013:

 

                  Weighted-         
           Weighted-      average      Aggregate  
           average      remaining      intrinsic  
     Shares     exercise      contractual      value  
Employee and director stock options    (millions)     price      term (yrs.)      (millions)  
                                    

Outstanding, beginning of period

     25     $ 50        

Granted

     6       60        

Exercised

     (10     48        

Forfeitures and expirations

     (1     55        
                                    

Outstanding, end of period

     20     $ 53        7.2      $ 111  
                                    

Exercisable, end of period

     10     $ 50        5.5      $ 88  
                                    
                                    

The weighted-average fair value of options granted was $6.70 per share and $5.92 per share for the year-to-date periods ended September 27, 2014 and September 28, 2013, respectively. The fair value was estimated using the following assumptions:

 

      Weighted-
average
expected
volatility
    Weighted-
average
expected
term
(years)
     Weighted-
average
risk-free
interest
rate
    Dividend
yield
 

Grants within the year-to-date period ended September 27, 2014:

     15     7.34        2.35     3.00

Grants within the year-to-date period ended September 28, 2013:

     15     7.44        1.49     2.90
                                   

The total intrinsic value of options exercised was $44 million and $133 million for the year-to-date periods ended September 27, 2014 and September 28, 2013, respectively.

Performance shares

In the first quarter of 2014, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year operating profit and internal net sales growth targets are achieved.

The 2014 target grant currently corresponds to approximately 223,000 shares, with a grant-date fair value of $54 per share. The actual number of shares issued on the vesting date could range from 0 to 200% of target, depending on actual performance achieved. Based on the market price of the Company’s common stock at September 27, 2014, the maximum future value that could be awarded to employees on the vesting date for all outstanding performance share awards was as follows:

 

(millions)    September 27,
2014
 

2012 Award

   $ 22  

2013 Award

   $ 24  

2014 Award

   $ 28  
          

The 2011 performance share award, payable in stock, was settled at 60% of target in February 2014 for a total dollar equivalent of $3 million.

 

17


Table of Contents

Note 7 Employee benefits

The Company sponsors a number of U.S. and foreign pension plans, as well as other nonpension postretirement and postemployment plans to provide various benefits for its employees. These plans are described within the footnotes to the Consolidated Financial Statements included in the Company’s 2013 Annual Report on Form 10-K. Components of Company plan benefit expense for the periods presented are included in the tables below.

Pension

 

     Quarter ended     Year-to-date period  ended  
(millions)    September 27, 2014     September 28, 2013     September 27, 2014     September 28, 2013  

Service cost

   $ 27     $ 33     $ 80     $ 101  

Interest cost

     56       51       169       151  

Expected return on plan assets

     (104     (90     (313     (269

Amortization of unrecognized prior service cost

     3       4       10       12  
                                  

Total pension expense (income)

   $ (18 )    $ (2   $ (54 )    $ (5
                                  
                                  

Other nonpension postretirement

 

        
     Quarter ended     Year-to-date period ended  
(millions)    September 27, 2014     September 28, 2013     September 27, 2014     September 28, 2013  

Service cost

   $ 7     $ 8     $ 21     $ 25  

Interest cost

     13       13       40       37  

Expected return on plan assets

     (24     (21     (73     (65

Amortization of unrecognized prior service cost

     (1 )     —          (2     (2

Recognized net loss

     7       —          7        —     

Curtailment gain

     (12 )     —          (12     —     
                                  

Total postretirement benefit expense (income)

   $ (10 )    $ —        $ (19 )    $ (5
                                  
                                  

Postemployment

 

        
     Quarter ended     Year-to-date period ended  
(millions)    September 27, 2014     September 28, 2013     September 27, 2014     September 28, 2013  

Service cost

   $ 2     $ 2     $ 6     $ 5  

Interest cost

     1       1       3       3  

Recognized net loss

     1       1       3       4  
                                  

Total postemployment benefit expense

   $ 4     $ 4     $ 12     $ 12  
                                  
                                  

During the quarter ended September 27, 2014, the Company recognized a curtailment gain of $12 million in conjunction with Project K restructuring activity. In addition, the Company remeasured the benefit obligation for the impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate.

Company contributions to employee benefit plans are summarized as follows:

 

            Nonpension         
(millions)    Pension      postretirement      Total  

Quarter ended:

        

September 27, 2014

   $ 5      $ 2      $ 7  

September 28, 2013

   $ 2      $ 4      $ 6  
                            

Year-to-date period ended:

        

September 27, 2014

   $ 34      $ 10      $ 44  

September 28, 2013

   $ 30      $ 12      $ 42  
                            

Full year:

        

Fiscal year 2014 (projected)

   $ 43      $ 14      $ 57  

Fiscal year 2013 (actual)

   $ 34      $ 14      $ 48  
                            

Plan funding strategies may be modified in response to management’s evaluation of tax deductibility, market conditions, and competing investment alternatives.

Note 8 Income taxes

The consolidated effective tax rate for the quarters ended September 27, 2014 and September 28, 2013 were 27.7% and 27.4%, respectively. The consolidated effective tax rate for both year-to-date periods ended September 27, 2014 and September 28, 2013 was 28.6%.

As of September 27, 2014, the Company classified $6 million of unrecognized tax benefits as a net current liability. Management’s estimate of reasonably possible changes in unrecognized tax benefits during the next twelve months is comprised of the current liability balance which is expected to be settled within one year, offset by approximately $8 million of projected additions related primarily to ongoing intercompany transfer pricing activity. Management is currently

 

18


Table of Contents

unaware of any issues under review that could result in significant additional payments, accruals or other material deviation in this estimate.

Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the year-to-date period ended September 27, 2014; $61 million of this total represents the amount that, if recognized, would affect the Company’s effective income tax rate in future periods.

 

(millions)  

December 28, 2013

   $ 79  

Tax positions related to current year:

     

Additions

        7  

Reductions

        —    

Tax positions related to prior years:

     

Additions

        6  

Reductions

        (9

Settlements

     1  
               

September 27, 2014

     $84  
               

For the year-to-date period ended September 27, 2014 the Company recognized an increase of $3 million for tax-related interest and penalties. The Company recognized no cash settlements during the current quarter. The accrual balance was $20 million at September 27, 2014.

Note 9 Derivative instruments and fair value measurements

The Company is exposed to certain market risks such as changes in interest rates, foreign currency exchange rates, and commodity prices, which exist as a part of its ongoing business operations. Management uses derivative and non-derivative financial instruments and commodity instruments, including futures, options, and swaps, where appropriate, to manage these risks. Instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged.

The Company designates derivatives as cash flow hedges, fair value hedges, net investment hedges, and uses other contracts to reduce volatility in interest rates, foreign currency and commodities. As a matter of policy, the Company does not engage in trading or speculative hedging transactions.

Total notional amounts of the Company’s derivative instruments as of September 27, 2014 and December 28, 2013 were as follows:

 

     September 27,      December 28,  
(millions)    2014      2013  

Foreign currency exchange contracts

   $ 735      $ 517  

Interest rate contracts

     2,997        2,400  

Commodity contracts

     519        361  
                   

Total

   $ 4,251      $ 3,278  
                   
                   

Following is a description of each category in the fair value hierarchy and the financial assets and liabilities of the Company that were included in each category at September 27, 2014 and December 28, 2013, measured on a recurring basis.

Level 1 – Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market. For the Company, level 1 financial assets and liabilities consist primarily of commodity derivative contracts.

Level 2 – Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. For the Company, level 2 financial assets and liabilities consist of interest rate swaps and over-the-counter commodity and currency contracts.

The Company’s calculation of the fair value of interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the interest rate curve. Over-the-counter commodity derivatives are valued using an income approach based on the commodity index prices less the contract rate multiplied by the notional amount. Foreign currency contracts are valued using an income approach based on forward rates less the contract rate multiplied by the

 

19


Table of Contents

notional amount. The Company’s calculation of the fair value of level 2 financial assets and liabilities takes into consideration the risk of nonperformance, including counterparty credit risk.

Level 3 – Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability. The Company did not have any level 3 financial assets or liabilities as of September 27, 2014 or December 28, 2013.

The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of September 27, 2014 and December 28, 2013:

Derivatives designated as hedging instruments

 

     September 27, 2014     December 28, 2013  
(millions)    Level 1      Level 2     Total     Level 1      Level 2     Total  

Assets:

              

Foreign currency exchange contracts:

              

Other prepaid assets

   $  —        $ 14     $ 14     $  —        $ 7     $ 7  
                                                    

Total assets

   $  —        $ 14     $ 14     $  —        $ 7     $ 7  
                                                    
                                                    

Liabilities:

              

Foreign currency exchange contracts:

              

Other current liabilities

   $  —        $ (6   $ (6   $  —        $ (8   $ (8

Interest rate contracts:

              

Other current liabilities

     —          (25     (25     —          —         —    

Other liabilities (a)

     —          (38     (38     —          (59     (59

Commodity contracts:

              

Other current liabilities

     —          (10     (10     —          (9     (9

Other liabilities

     —          (12     (12     —          (19     (19
                                                    

Total liabilities

   $  —        $ (91   $ (91   $  —        $ (95   $ (95
                                                    
                                                    

 

(a) The fair value of the related hedged portion of the Company’s long-term debt, a level 2 liability, was $2.5 billion as of September 27, 2014 and December 28, 2013.

Derivatives not designated as hedging instruments

 

     September 27, 2014     December 28, 2013  
(millions)    Level 1     Level 2      Total     Level 1     Level 2      Total  

Assets:

              

Commodity contracts:

              

Other prepaid assets

   $  —       $  —        $  —       $ 3     $  —        $ 3  
                                                    

Total assets

   $  —       $  —        $  —       $ 3     $  —        $ 3  
                                                    
                                                    

Liabilities:

              

Commodity contracts:

              

Other current liabilities

   $ (35   $  —        $ (35   $ (7   $  —        $ (7
                                                    

Total liabilities

   $ (35   $  —        $ (35   $ (7   $  —        $ (7
                                                    
                                                    

During the second quarter of 2014, the Company designated a portion of its outstanding foreign currency denominated long-term debt as a net investment hedge of a portion of the Company’s investment in its subsidiaries foreign currency denominated net assets. The carrying value of this debt was $639 million as of September 27, 2014.

 

20


Table of Contents

The Company has elected to not offset the fair values of derivative assets and liabilities executed with the same counterparty that are generally subject to enforceable netting agreements. However, if the Company were to offset and record the asset and liability balances of derivatives on a net basis, the amounts presented in the Consolidated Balance Sheet as of September 27, 2014 and December 28, 2013 would be adjusted as detailed in the following table:

 

As of September 27, 2014:                    
           Gross Amounts Not Offset in the
Consolidated Balance Sheet
        
      Amounts
Presented in
the
Consolidated
Balance Sheet
    Financial
Instruments
    Cash
Collateral
Received/
Posted
     Net
Amount
 

Total asset derivatives

   $ 14     $ (11   $  —        $ 3  

Total liability derivatives

   $ (126   $  11     $ 64      $ (51
                                   
         

As of December 28, 2013:

         
           Gross Amounts Not Offset in the
Consolidated Balance Sheet
        
      Amounts
Presented in the
Consolidated
Balance Sheet
    Financial
Instruments
    Cash Collateral
Received/
Posted
     Net
Amount
 

Total asset derivatives

   $ 10      $ (10   $ —        $ —    

Total liability derivatives

   $ (102   $  10     $ 21      $ (71
                                   

 

21


Table of Contents

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the quarters ended September 27, 2014 and September 28, 2013 was as follows:

Derivatives in fair value hedging relationships

 

(millions)                   Location of gain (loss)
recognized in income
 

Gain (loss)
recognized in

income (a)

 
                     Sep. 27,     Sep. 28,  
                     2014     2013  

Foreign currency exchange contracts

         Other income (expense), net   $ 1     $ (1

Interest rate contracts

         Interest expense     4       (3 )
                                  

Total

           $ 5     $ (4 )
                                  
                                  

 

(a) Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives in cash flow hedging relationships

 

(millions)    Gain (loss)
recognized in AOCI
    Location of gain
(loss)
reclassified from
AOCI
   Gain (loss)
reclassified from
AOCI into income
    Location of
gain (loss)
recognized
in income (a)
  Gain (loss)
recognized in
income (a)
 
     Sep. 27,
2014
    Sep. 28,
2013
         Sep. 27,
2014
    Sep. 28,
2013
        Sep. 27,
2014
    Sep. 28,
2013
 

Foreign currency exchange contracts

   $ 16      $ (4 )   COGS    $  —       $ 2     Other income (expense), net   $ (1   $  —    

Foreign currency exchange contracts

     3       (3 )   SGA expense      2       1     Other income (expense), net     —         —    

Interest rate contracts

     (20     —       Interest expense      —         1     N/A     —         —    

Commodity contracts

     (1 )     —        COGS      (2     (2   Other income (expense), net     —         —    
                                                           

Total

   $ (2   $ (7 )      $  —       $ 2        $ (1   $  —    
                                                           
                                                           

 

(a) Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives and non-derivatives in net investment hedging relationships

 

(millions)             

Gain (loss)
recognized in

AOCI

 
             Sep. 27,     Sep. 28,  
             2014     2013  

Foreign currency denominated long-term debt

       $ 42     $  —    
                          

Total

       $ 42     $  —    
                          
                          

 

Derivatives not designated as hedging instruments

 

          
(millions)        

Location of gain

(loss) recognized

in income

  Gain (loss)
recognized in
income
 
             Sep. 27,     Sep. 28,  
             2014     2013  

Foreign currency exchange contracts

     Other income (expense), net   $ 1     $ 1   

Commodity contracts

     COGS     (61     (2
                          

Total

       $ (60 )    $ (1
                          
                          

 

22


Table of Contents

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the year-to-date periods ended September 27, 2014 and September 28, 2013 were as follows:

Derivatives in fair value hedging relationships

 

(millions)              Location of gain (loss)
recognized in income
 

Gain (loss)
recognized in

income(a)

 
                 Sep. 27,     Sep. 28,  
                 2014     2013  

Foreign currency exchange contracts

       Other income (expense), net   $ 3     $ 2  

Interest rate contracts

       Interest expense     13       (2 )
                              

Total

         $ 16     $  —    
                              
                              

 

(a) Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives in cash flow hedging relationships

 

(millions)    Gain (loss)
recognized in AOCI
    Location of gain
(loss) reclassified
from AOCI
   Gain (loss)
reclassified from
AOCI into income
    Location of gain
(loss) recognized
in income (a)
  Gain (loss)
recognized in
income(a)
 
     Sep. 27,     Sep. 28,          Sep. 27,     Sep. 28,         Sep. 27,     Sep. 28,  
     2014     2013          2014     2013         2014     2013  

Foreign currency exchange contracts

   $ 13      $ 8     COGS    $ 2     $ 7     Other income (expense), net   $ (3   $  —    

Foreign currency exchange contracts

     4       (2 )   SGA expense      5       1     Other income (expense), net     —         —    

Interest rate contracts

     (43     —       Interest expense      9       3     N/A     —         —    

Commodity contracts

     —         (1   COGS      (5     (7   Other income (expense), net     —         —    
                                                           

Total

   $ (26   $ 5        $ 11     $ 4        $ (3   $  —    
                                                           
                                                           

 

(a) Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives and non-derivatives in net investment hedging relationships

 

(millions)             

Gain (loss)
recognized in

AOCI

 
             Sep. 27,      Sep. 28,  
             2014      2013  

Foreign currency denominated long-term debt

       $ 47      $  —    
                           

Total

       $ 47      $  —    
                           
                           

Derivatives not designated as hedging instruments

 

(millions)              Location of gain
(loss) recognized
in income
  Gain (loss)
recognized in
income
 
                 Sep. 27,     Sep. 28,  
                 2014     2013  

Foreign currency exchange contracts

       COGS   $  —       $ 2  

Foreign currency exchange contracts

       Other income (expense), net     (1     —    

Interest rate contracts

       Interest expense     (4     —    

Commodity contracts

       COGS     (66     (26
                              

Total

         $ (71 )    $ (24
                              
                              

 

23


Table of Contents

During the next 12 months, the Company expects $2 million of net deferred losses reported in AOCI at September 27, 2014 to be reclassified to income, assuming market rates remain constant through contract maturities.

Certain of the Company’s derivative instruments contain provisions requiring the Company to post collateral on those derivative instruments that are in a liability position if the Company’s credit rating is at or below BB+ (S&P), or Baa1 (Moody’s). The fair value of all derivative instruments with credit-risk-related contingent features in a liability position on September 27, 2014 was $79 million. If the credit-risk-related contingent features were triggered as of September 27, 2014, the Company would be required to post additional collateral of $64 million. In addition, certain derivative instruments contain provisions that would be triggered in the event the Company defaults on its debt agreements. There were no collateral posting requirements as of September 27, 2014 triggered by credit-risk-related contingent features, however, there was $15 million of collateral posted in connection with reciprocal collateralization agreements as discussed under “Counterparty credit risk concentration and collateral requirements” below.

Fair Value Measurements on a Nonrecurring Basis

As part of Project K the Company will be consolidating the usage of and disposing certain long-lived assets, including manufacturing facilities and Corporate owned assets over the term of the program. See Note 3 for more information regarding Project K.

In the quarter ended September 27, 2014, long-lived assets of $24 million, related to a manufacturing facility in our U.S. Snacks segment, were written down to an estimated fair value of $3 million due to Project K activities. The Company’s calculation of the fair value of long-lived assets is based on Level 3 inputs, including market comparables, market trends and the condition of the assets.

The following table presents level 3 assets that were measured at fair value on the Consolidated Balance Sheet on a nonrecurring basis as of September 27, 2014:

 

(millions)    Fair Value      Total Loss  

Description:

     

Long-lived assets

   $ 3      $ (21
                   

Total

   $ 3      $ (21
                   
                   

Financial instruments

The carrying values of the Company’s short-term items, including cash, cash equivalents, accounts receivable, accounts payable and notes payable approximate fair value. The fair value of the Company’s long-term debt, which are level 2 liabilities, is calculated based on broker quotes and was as follows at September 27, 2014:

 

(millions)    Fair Value      Carrying Value  

Current maturities of long-term debt

   $ 607      $ 607  

Long-term debt

     6,471        5,963  
                   

Total

   $ 7,078      $ 6,570  
                   
                   

Counterparty credit risk concentration and collateral requirements

The Company is exposed to credit loss in the event of nonperformance by counterparties on derivative financial and commodity contracts. Management believes a concentration of credit risk with respect to derivative counterparties is limited due to the credit ratings and use of master netting and reciprocal collateralization agreements with the counterparties and the use of exchange-traded commodity contracts.

Master netting agreements apply in situations where the Company executes multiple contracts with the same counterparty. Certain counterparties represent a concentration of credit risk to the Company. If those counterparties fail to perform according to the terms of derivative contracts, this would result in a loss to the Company. As of September 27, 2014, the Company was not in a significant net asset position with any counterparties with which a master netting agreement would apply.

For certain derivative contracts, reciprocal collateralization agreements with counterparties call for the posting of collateral in the form of cash, treasury securities or letters of credit if a fair value loss position to the Company or its counterparties exceeds a certain amount. In addition, the Company is required to maintain cash margin accounts in connection with its open positions for exchange-traded commodity derivative instruments executed with the counterparty that are subject to enforceable netting agreements. As of September 27, 2014 the Company had posted collateral of $15 million in the form of cash, which was reflected as an increase in accounts receivable, net on the Consolidated Balance Sheet. As of September 27, 2014 the Company posted $49 million in margin deposits for exchange-traded commodity derivative instruments, which was reflected as an increase in accounts receivable, net.

 

24


Table of Contents

Management believes concentrations of credit risk with respect to accounts receivable is limited due to the generally high credit quality of the Company’s major customers, as well as the large number and geographic dispersion of smaller customers. However, the Company conducts a disproportionate amount of business with a small number of large multinational grocery retailers, with the five largest accounts encompassing approximately 27% of consolidated trade receivables at September 27, 2014.

Note 10 Contingencies

In connection with the Company’s on-going labor negotiations with the union representing the work-force at our Memphis, TN cereal production facility, the National Labor Relations Board filed a complaint alleging unfair labor practices under the National Labor Relations Act in March 2014. In July, 2014, a U.S. District Court judge ruled that the Memphis employees were entitled to return to work while the underlying litigation continues and employees have subsequently returned to work. This ruling is not expected to have a material effect on the production or distribution of products from the Memphis, TN facility or a material financial impact on the Company. As of September 27, 2014, the Company has not recorded a liability related to this matter due to the uncertainty of any potential outcome. The Company will continue to evaluate the likelihood of potential outcomes for this case as the litigation continues.

Note 11 Reportable segments

Kellogg Company is the world’s leading producer of cereal, second largest producer of cookies and crackers, and a leading producer of savory snacks and frozen foods. Additional product offerings include toaster pastries, cereal bars, fruit-flavored snacks and veggie foods. Kellogg products are manufactured and marketed globally. Principal markets for these products include the United States and United Kingdom.

The Company currently manages its operations through eight operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. The reportable segments are discussed in greater detail below.

U.S. Morning Foods includes cereal, toaster pastries, health and wellness bars, and beverages.

U.S. Snacks includes products such as cookies, crackers, cereal bars, savory snacks and fruit-flavored snacks.

U.S. Specialty includes the food service, convenience and Girl Scouts businesses. The food service business is mostly non-commercial, servicing institutions such as schools and hospitals.

North America Other includes the U.S. Frozen and Canada operating segments. As these operating segments are not considered economically similar enough to aggregate with other operating segments and are immaterial for separate disclosure, they have been grouped together as a single reportable segment.

The three remaining reportable segments are based on geographic location – Europe, which consists principally of European countries; Latin America, which is comprised of Central and South America and includes Mexico; and Asia Pacific, which is comprised of South Africa, Australia and other Asian and Pacific markets.

The measurement of reportable segment results is based on segment operating profit which is generally consistent with the presentation of operating profit in the Consolidated Statement of Income. Intercompany transactions between operating segments were insignificant in all periods presented.

 

25


Table of Contents
    Quarter ended     Year-to-date period  ended  
    September 27,     September 28,     September 27,     September 28,  
(millions)   2014     2013     2014     2013  

Net sales

       

U.S. Morning Foods

  $ 841     $ 883     $ 2,522     $ 2,657  

U.S. Snacks

    849       886       2,645       2,704  

U.S. Specialty

    270       281       918       932  

North America Other

    369       382       1,111       1,173  

Europe

    726       729       2,206       2,144  

Latin America

    320       302       918       914  

Asia Pacific

    264       253       746       767  
                                 

Consolidated

  $ 3,639     $ 3,716     $ 11,066     $ 11,291  
                                 

Operating profit

       

U.S. Morning Foods

  $ 118     $ 132     $ 389     $ 475  

U.S. Snacks

    67       105       292       341  

U.S. Specialty

    59       70       209       210  

North America Other

    58       70       192       223  

Europe

    61       74       181       220  

Latin America

    50       39       145       129  

Asia Pacific

    16       25       32       63  
                                 

Total Reportable Segments

    429       515       1,440       1,661  

Corporate

    (64     (11     6       (84
                                 

Consolidated

  $ 365     $ 504     $ 1,446     $ 1,577  
                                 
                                 

 

26


Table of Contents

KELLOGG COMPANY

PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand Kellogg Company, our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto contained in Item 1 of this report.

For more than 100 years, consumers have counted on Kellogg for great-tasting, high-quality and nutritious foods. Kellogg is the world’s leading producer of cereal, second largest producer of cookies and crackers, and a leading producer of savory snacks and frozen foods. Additional product offerings include toaster pastries, cereal bars, fruit-flavored snacks and veggie foods. Kellogg products are manufactured and marketed globally.

We manage our operations through eight operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. We report results of operations in the following reportable segments: U.S. Morning Foods; U.S. Snacks; U.S. Specialty; North America Other; Europe; Latin America; and Asia Pacific. The reportable segments are discussed in greater detail in Note 11 within Notes to Consolidated Financial Statements.

We manage our Company for sustainable performance defined by our long-term annual growth targets. These targets are 3 to 4% for internal net sales, mid-single-digit (4 to 6%) for underlying internal operating profit, and high-single-digit (7 to 9%) for currency-neutral comparable diluted net earnings per share.

During 2013 we announced Project K, a four-year efficiency and effectiveness program. The program is expected to generate a significant amount of savings that will be invested in key strategic areas of focus for the business. We expect that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow. See the Restructuring and cost reduction activities section for more information.

Comparability

Internal net sales growth excludes the impact of foreign currency translation and, if applicable, acquisitions, dispositions and integration costs associated with the acquisition of the Pringles® business (Pringles).

Comparability of certain financial measures is impacted significantly by two types of charges: 1) Mark-to-market adjustments that are recorded for pensions and commodity derivative contracts; and 2) Charges related to restructuring and cost reduction activities. To provide increased transparency and assist in understanding our underlying operating performance we use non-GAAP financial measures within the MD&A that exclude the impact of these charges. These non-GAAP financial measures include underlying gross margin, underlying gross profit, underlying SGA%, underlying operating margin, underlying operating profit, underlying operating profit growth, underlying income taxes, underlying effective tax rate, and underlying net income attributable to Kellogg Company.

Underlying internal operating profit growth excludes the impact of foreign currency translation and, if applicable, acquisitions, dispositions, integration costs associated with the acquisition of Pringles, mark-to-market adjustments, and charges related to restructuring and cost reduction activities.

Additionally, integration costs associated with the acquisition of Pringles are excluded from comparable basic earnings per share (EPS), comparable diluted EPS, and comparable diluted EPS growth.

Financial results

For the quarter ended September 27, 2014, our reported net sales declined by 2.1% and internal net sales declined by 1.7%. We experienced internal net sales declines in U.S. Morning Foods, U.S. Snacks, U.S. Specialty, North America Other, and Europe. Internal net sales grew in Latin America and Asia Pacific. Reported operating profit declined by 27.5%, and underlying internal operating profit declined by 1.8%. The decline in underlying internal operating profit was driven by softer sales primarily in U.S. Morning Foods, U.S. Snacks, and U.S. Specialty. This was partially offset by net cost deflation, continued discipline in overhead control, reduced incentive compensation to align with performance, and slightly lower investment in brand-building.

Reported diluted EPS of $.62 for the quarter was down 31.1% compared to the prior year of $.90. Comparable diluted EPS of $.94 for the quarter was down 3.1% compared to the prior year of $.97.

As a result of 2014 incentive compensation being reduced in the current quarter to align with performance and the anticipated re-establishment of usual incentive compensation levels in 2015, we expect that increased incentive compensation will result in a 2%-3% headwind for full-year results in 2015.

 

27


Table of Contents

Reconciliation of certain non-GAAP Financial Measures

 

     Quarter ended     Year-to-date period ended  
                                  
Consolidated results    September 27,     September 28,     September 27,     September 28,  
     2014     2013     2014     2013  
                                  
                                  

Reported operating profit

   $ 365     $ 504     $ 1,446     $ 1,577  

Mark-to-market (a)

     (66     2       38       (59

Restructuring and cost reduction activities (b)

     (92     (29     (224     (49
                                  

Underlying operating profit (c)

   $ 523     $ 531     $ 1,632     $ 1,685  
                                  
                                  

Reported income taxes

   $ 86     $ 124     $ 373     $ 398  

Mark-to-market (a)

     (25           7       (19

Restructuring and cost reduction activities (b)

     (24     (8     (62     (15
                                  

Underlying income taxes (c)

   $ 135     $ 132     $ 428     $ 432  
                                  
                                  

Reported effective income tax rate

     27.7     27.4     28.6     28.6

Mark-to-market (a)

     (1.3 )%            (0.3 )%      (0.2 )% 

Restructuring and cost reduction activities (b)

     0.5     (0.3 )%      0.2  </