Annual Reports

  • 10-K (Feb 24, 2014)
  • 10-K (Feb 26, 2013)
  • 10-K (Feb 25, 2011)
  • 10-K (Feb 26, 2010)
  • 10-K (Feb 24, 2009)
  • 10-K (Feb 25, 2008)

 
Quarterly Reports

 
8-K

 
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Kellogg Company 10-K 2010
Form 10-K

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

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

For the Fiscal Year Ended January 2, 2010

 

¨ 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

(Exact name of registrant as specified in its charter)

 

Delaware   38-0710690

(State or other jurisdiction of Incorporation

or organization)

  (I.R.S. Employer Identification No.)

 

 

One Kellogg Square

Battle Creek, Michigan 49016-3599

(Address of Principal Executive Offices)

Registrant’s telephone number: (269) 961-2000

 

 

Securities registered pursuant to Section 12(b) of the Securities Act:

 

Title of each class:   Name of each exchange on which registered:
Common Stock, $.25 par value per share   New York Stock Exchange

 

 

Securities registered pursuant to Section 12(g) of the Securities Act: None

 

 

Indicate by a check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.    Yes  ¨    No  þ

Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

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  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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. (Check one)

 

Large accelerated filer    þ   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 Act).    Yes  ¨    No  þ

The aggregate market value of the common stock held by non-affiliates of the registrant (assuming only for purposes of this computation that the W. K. Kellogg Foundation Trust, directors and executive officers may be affiliates) as of the close of business on July 4, 2009 was approximately $13.7 billion based on the closing price of $46.82 for one share of common stock, as reported for the New York Stock Exchange on that date.

As of January 29, 2010, 380,565,213 shares of the common stock of the registrant were issued and outstanding.

Parts of the registrant’s Proxy Statement for the Annual Meeting of Shareowners to be held on April 23, 2010 are incorporated by reference into Part III of this Report.

 

 

 


PART 1.

 

ITEM 1. BUSINESS

The Company.  Kellogg Company, founded in 1906 and incorporated in Delaware in 1922, and its subsidiaries are engaged in the manufacture and marketing of ready-to-eat cereal and convenience foods.

The address of the principal business office of Kellogg Company is One Kellogg Square, P.O. Box 3599, Battle Creek, Michigan 49016-3599. Unless otherwise specified or indicated by the context, “Kellogg,” “we,” “us” and “our” refer to Kellogg Company, its divisions and subsidiaries.

Financial Information About Segments.  Information on segments is located in Note 17 within Notes to the Consolidated Financial Statements.

Principal Products.  Our principal products are ready-to-eat cereals and convenience foods, such as cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles and veggie foods. These products were, as of February 26, 2010, manufactured by us in 18 countries and marketed in more than 180 countries. Our cereal products are generally marketed under the Kellogg’s name and are sold principally to the grocery trade through direct sales forces for resale to consumers. We use broker and distribution arrangements for certain products. We also generally use these, or similar arrangements, in less-developed market areas or in those market areas outside of our focus.

We also market cookies, crackers, and other convenience foods, under brands such as Kellogg’s, Keebler, Cheez-It, Murray, Austin and Famous Amos, to supermarkets in the United States through a direct store-door (DSD) delivery system, although other distribution methods are also used.

Additional information pertaining to the relative sales of our products for the years 2007 through 2009 is located in Note 17 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.

Raw Materials.  Agricultural commodities are the principal raw materials used in our products. Cartonboard, corrugated, and plastic are the principal packaging materials used by us. World supplies and prices of such commodities (which include such packaging materials) are constantly monitored, as are government trade policies. The cost of such commodities may fluctuate widely due to government policy and regulation, weather conditions, or other unforeseen circumstances. Continuous efforts are made to maintain and improve the quality and supply of such commodities for purposes of our short-term and long-term requirements.

The principal ingredients in the products produced by us in the United States include corn grits, wheat and wheat derivatives, oats, rice, cocoa and chocolate, soybeans and soybean derivatives, various fruits, sweeteners, flour, vegetable oils, dairy products, eggs, and other filling ingredients, which are obtained from various sources. Most of these commodities are purchased principally from sources in the United States.

We enter into long-term contracts for the commodities described in this section and purchase these items on the open market, depending on our view of possible price fluctuations, supply levels, and our relative negotiating power. While the cost of some of these commodities has, and may continue to, increase over time, we believe that we will be able to purchase an adequate supply of these items as needed. As further discussed herein under Part II, Item 7A, we also use commodity futures and options to hedge some of our costs.

Raw materials and packaging needed for internationally based operations are available in adequate supply and are sometimes imported from countries other than those where used in manufacturing.

Natural gas and propane are the primary sources of energy used to power processing ovens at major domestic and international facilities, although certain locations may use oil or propane on a back-up or alternative basis. In addition, considerable amounts of diesel fuel are used in connection with the distribution of our products. As further discussed herein under Part II, Item 7A, we use over-the-counter commodity price swaps to hedge some of our natural gas costs.

Trademarks and Technology.  Generally, our products are marketed under trademarks we own. Our principal trademarks are our housemarks, brand names, slogans, and designs related to cereals and convenience foods manufactured and marketed by us, and we also grant licenses to third parties to use these marks on various goods. These trademarks include Kellogg’s for cereals, convenience foods and our other products, and the brand names of certain ready-to-eat cereals, including All-Bran, Apple Jacks, Bran Buds, Complete Bran Flakes, Complete Wheat

Flakes, Cocoa Krispies, Cinnamon Crunch Crispix, Corn Pops, Cruncheroos, Kellogg’s Corn Flakes, Cracklin’ Oat Bran, Crispix, Froot Loops, Kellogg’s

 

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Frosted Flakes, Frosted Mini-Wheats, Frosted Krispies, Just Right, Kellogg’s Low Fat Granola, Mueslix, Pops, Product 19, Kellogg’s Raisin Bran, Rice Krispies, Raisin Bran Crunch, Smacks/Honey Smacks, Smart Start, Special K and Special K Red Berries in the United States and elsewhere; Zucaritas, Choco Zucaritas, Crusli, Sucrilhos, Sucrilhos Chocolate, Sucrilhos Banana, Vector, Musli, NutriDia, and Choco Krispis for cereals in Latin America; Vive and Vector in Canada; Choco Pops, Chocos, Crunch Red Nut, Frosties, Muslix, Fruit’n’ Fibre, Kellogg’s Crunchy Nut Corn Flakes, Honey Loops, Kellogg’s Extra, Sustain, Muslix, Country Store, Ricicles, Smacks, Start, Pops, Optima and Tresor for cereals in Europe; and Cerola, Sultana Bran, Chex, Frosties, Goldies, Rice Bubbles, Nutri-Grain, Kellogg’s Iron Man Food, and BeBig for cereals in Asia and Australia. Additional Company trademarks are the names of certain combinations of ready-to-eat Kellogg’s cereals, including Fun Pak, Jumbo, and Variety.

Other Company brand names include Kellogg’s Corn Flake Crumbs; Croutettes for herb season stuffing mix; All-Bran, Choco Krispis, Froot Loops, NutriDia, Kuadri-Krispis, Zucaritas, Special K, and Crusli for cereal bars, Keloketas for cookies, Komplete for biscuits; and Kaos for snacks in Mexico and elsewhere in Latin America; Pop-Tarts Pastry Swirls for toaster danish; Pop-Tarts and Pop-Tarts Snak-Stix for toaster pastries; Eggo, Special K, Froot Loops and Nutri-Grain for frozen waffles and pancakes; Rice Krispies Treats for baked snacks and convenience foods; Special K and Special K2O flavored water and flavored protein water mixes; Nutri-Grain cereal bars, Nutri-Grain yogurt bars, All-Bran bars and crackers, for convenience foods in the United States and elsewhere; K-Time, Rice Bubbles, Day Dawn, Be Natural, Sunibrite and LCMs for convenience foods in Asia and Australia; Nutri-Grain Squares, Nutri-Grain Elevenses, and Rice Krispies Squares for convenience foods in Europe; Fruit Winders for fruit snacks in the United Kingdom; Kashi and GoLean for certain cereals, nutrition bars, and mixes; TLC for granola and cereal bars, crackers and cookies; Special K and Vector for meal replacement products; Bear Naked for granola cereal, bars and trail mix and Morningstar Farms, Loma Linda, Natural Touch, Gardenburger and Worthington for certain meat and egg alternatives.

We also market convenience foods under trademarks and tradenames which include Keebler, Cheez-It, E. L. Fudge, Murray, Famous Amos, Austin, Ready Crust, Chips Deluxe, Club, Kellogg’s FiberPlus, Fudge Shoppe, Hi-Ho, Sunshine, Krispy, Mother’s, Munch’Ems, Right Bites, Sandies, Soft Batch, Stretch Island, Toasteds, Town House, Vienna Fingers, Wheatables, and Zesta. One of our subsidiaries is also the exclusive licensee of the Carr’s cracker and cookie line in the United States.

 

Our trademarks also include logos and depictions of certain animated characters in conjunction with our products, including Snap!Crackle!Pop! for Cocoa Krispies and Rice Krispies cereals and Rice Krispies Treats convenience foods; Tony the Tiger for Kellogg’s Frosted Flakes, Zucaritas, Sucrilhos and Frosties cereals and convenience foods; Ernie Keebler for cookies, convenience foods and other products; the Hollow Tree logo for certain convenience foods; Toucan Sam for Froot Loops; Dig ‘Em for Smacks; Sunny for Kellogg’s Raisin Bran, Coco the Monkey for Coco Pops; Cornelius for Kellogg’s Corn Flakes; Melvin the Elephant for certain cereal and convenience foods; Chocos the Bear, Kobi the Bear and Sammy the Seal for certain cereal products.

The slogans The Best To You Each Morning, The Original & Best, They’re Gr-r-reat!, The Difference is K, One Bowl Stronger, Supercharged, Earn Your Stripes and Gotta Have My Pops, used in connection with our ready-to-eat cereals, along with L’ Eggo my Eggo, used in connection with our frozen waffles and pancakes, Elfin Magic, Childhood Is Calling, The Cookies in the Passionate Purple Package and Uncommonly Good used in connection with convenience food products, Seven Whole Grains on a Mission used in connection with Kashi all-natural foods and See Veggies Differently used in connection with meat and egg alternatives are also important Kellogg trademarks.

The trademarks listed above, among others, when taken as a whole, are important to our business. Certain individual trademarks are also important to our business. Depending on the jurisdiction, trademarks are generally valid as long as they are in use and/or their registrations are properly maintained and they have not been found to have become generic. Registrations of trademarks can also generally be renewed indefinitely as long as the trademarks are in use.

We consider that, taken as a whole, the rights under our various patents, which expire from time to time, are a valuable asset, but we do not believe that our businesses are materially dependent on any single patent or group of related patents. Our activities under licenses or other franchises or concessions which we hold are similarly a valuable asset, but are not believed to be material.

Seasonality.   Demand for our products has generally been approximately level throughout the year, although some of our convenience foods have a bias for stronger demand in the second half of the year due to events and holidays. We also custom-bake cookies for the Girl Scouts of the U.S.A., which are principally sold in the first quarter of the year.

 

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Working Capital.  Although terms vary around the world and by business types, in the United States we generally have required payment for goods sold eleven or sixteen days subsequent to the date of invoice as 2% 10/net 11 or 1% 15/net 16. Receipts from goods sold, supplemented as required by borrowings, provide for our payment of dividends, repurchases of our common stock, capital expansion, and for other operating expenses and working capital needs.

Customers.  Our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 21% of consolidated net sales during 2009, comprised principally of sales within the United States. At January 2, 2010, approximately 17% of our consolidated receivables balance and 26% of our U.S. receivables balance was comprised of amounts owed by Wal-Mart Stores, Inc. and its affiliates. No other customer accounted for greater than 10% of net sales in 2009. During 2009, our top five customers, collectively, including Wal-Mart, accounted for approximately 34% of our consolidated net sales and approximately 44% of U.S. net sales. There has been significant worldwide consolidation in the grocery industry in recent years and we believe that this trend is likely to continue. Although the loss of any large customer for an extended length of time could negatively impact our sales and profits, we do not anticipate that this will occur to a significant extent due to the consumer demand for our products and our relationships with our customers. Our products have been generally sold through our own sales forces and through broker and distributor arrangements, and have been generally resold to consumers in retail stores, restaurants, and other food service establishments.

Backlog.  For the most part, orders are filled within a few days of receipt and are subject to cancellation at any time prior to shipment. The backlog of any unfilled orders at January 2, 2010 and January 3, 2009 was not material to us.

Competition.  We have experienced, and expect to continue to experience, intense competition for sales of all of our principal products in our major product categories, both domestically and internationally. Our products compete with advertised and branded products of a similar nature as well as unadvertised and private label products, which are typically distributed at lower prices, and generally with other food products. Principal methods and factors of competition include new product introductions, product quality, taste, convenience, nutritional value, price, advertising and promotion.

Research and Development.  Research to support and expand the use of our existing products and to develop new food products is carried on at the W. K. Kellogg Institute for Food and Nutrition Research in Battle Creek, Michigan, and at other locations around the world. Our expenditures for research and development were approximately $181 million in 2009 and 2008 and $179 million in 2007.

Regulation.  Our activities in the United States are subject to regulation by various government agencies, including the Food and Drug Administration, Federal Trade Commission and the Departments of Agriculture, Commerce and Labor, as well as voluntary regulation by other bodies. Various state and local agencies also regulate our activities. Other agencies and bodies outside of the United States, including those of the European Union and various countries, states and municipalities, also regulate our activities.

Environmental Matters.  Our facilities are subject to various U.S. and foreign, federal, state, and local laws and regulations regarding the discharge of material into the environment and the protection of the environment in other ways. We are not a party to any material proceedings arising under these regulations. We believe that compliance with existing environmental laws and regulations will not materially affect our consolidated financial condition or our competitive position.

Employees.  At January 2, 2010, we had approximately 30,900 employees.

Financial Information About Geographic Areas.  Information on geographic areas is located in Note 17 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.

Executive Officers.  The names, ages, and positions of our executive officers (as of February 26, 2010) are listed below, together with their business experience. Executive officers are generally elected annually by the Board of Directors at the meeting immediately prior to the Annual Meeting of Shareowners.

 

James M. Jenness

  63

Chairman of the Board

Mr. Jenness has been our Chairman since February 2005 and has served as a Kellogg director since 2000. From February 2005 until December 2006, he also served as our Chief Executive Officer. He was Chief Executive Officer of Integrated Merchandising Systems, LLC, a leader in outsource management of retail promotion and branded merchandising from 1997 to December 2004. He is also a director of Kimberly-Clark Corporation.

 

A. D. David Mackay

  54

President and Chief Executive Officer

Mr. Mackay became our President and Chief Executive Officer on December 31, 2006 and has served as a Kellogg director since February 2005. Mr. Mackay joined Kellogg Australia in 1985 and held several

 

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positions with Kellogg USA, Kellogg Australia and Kellogg New Zealand before leaving Kellogg in 1992. He rejoined Kellogg Australia in 1998 as Managing Director and was appointed Managing Director of Kellogg United Kingdom and Republic of Ireland later in 1998. He was named Senior Vice President and President, Kellogg USA in July 2000, Executive Vice President in November 2000, and President and Chief Operating Officer in September 2003. He is also a director of Fortune Brands, Inc.

 

John A. Bryant

  44

Executive Vice President and Chief Operating Officer

Mr. Bryant joined Kellogg in March 1998, working in support of the global strategic planning process. He was appointed Senior Vice President and Chief Financial Officer, Kellogg USA, in August 2000, was appointed as Kellogg’s Chief Financial Officer in February 2002 and was appointed Executive Vice President later in 2002. He also assumed responsibility for the Natural and Frozen Foods Division, Kellogg USA, in September 2003. He was appointed Executive Vice President and President, Kellogg International in June 2004 and was appointed Executive Vice President and Chief Financial Officer, Kellogg Company, President, Kellogg International in December 2006. In July 2007, Mr. Bryant was appointed Executive Vice President and Chief Financial Officer, Kellogg Company, President, Kellogg North America and in August 2008, he was appointed Executive Vice President, Chief Operating Officer and Chief Financial Officer. Mr. Bryant served as Chief Financial Officer through December 2009.

 

Celeste Clark

  56

Senior Vice President, Global Nutrition and

Corporate Affairs, Chief Sustainability Officer

Dr. Clark has been Kellogg’s Senior Vice President of Global Nutrition and Corporate Affairs since June 2006. She joined Kellogg in 1977 and served in several roles of increasing responsibility before being appointed to Vice President, Worldwide Nutrition Marketing in 1996 and then to Senior Vice President, Nutrition and Marketing Communications, Kellogg USA in 1999. She was appointed to Vice President, Corporate and Scientific Affairs in October 2002, and to Senior Vice President, Corporate Affairs in August 2003. Her responsibilities were expanded in 2008 to include sustainability.

 

Bradford J. Davidson

  49

Senior Vice President, Kellogg Company

President, Kellogg North America

Brad Davidson was appointed President, Kellogg North America in August 2008. Mr. Davidson joined Kellogg Canada as a sales representative in 1984. He held numerous positions in Canada, including manager of trade promotions, account executive, brand manager, area sales manager, director of customer marketing and category management, and director of Western Canada. Mr. Davidson transferred to Kellogg USA in 1997 as director, trade marketing. He later was promoted to Vice President, Channel Sales and Marketing and then to Vice President, National Teams Sales and Marketing. In 2000, he was promoted to Senior Vice President, Sales for the Morning Foods Division, Kellogg USA, and to Executive Vice President and Chief Customer Officer, Morning Foods Division, Kellogg USA in 2002. In June 2003, Mr. Davidson was appointed President, U.S. Snacks and promoted in August 2003 to Senior Vice President.

 

Ronald L. Dissinger

  51

Senior Vice President and Chief Financial Officer

Ron Dissinger was appointed Senior Vice President and Chief Financial Officer effective January 2010. Mr. Dissinger joined Kellogg in 1987 as an accounting supervisor, and during the next 14 years served in a number of key financial leadership roles, both in the United States and Australia. In 2001, he was promoted to Vice President and Chief Financial Officer, U.S. Morning Foods. In 2004, Ron became Vice President, Corporate Financial Planning, and CFO, Kellogg International. In 2005, Ron became Vice President and CFO, Kellogg Europe and CFO, Kellogg International. In 2007, he was appointed Senior Vice President and Chief Financial Officer, Kellogg North America.

 

Timothy P. Mobsby

  54

Senior Vice President, Kellogg Company

Executive Vice President, Kellogg International and

President, Kellogg Europe

Tim Mobsby has been Senior Vice President, Kellogg Company; Executive Vice President, Kellogg International; and President, Kellogg Europe since October 2000. Mr. Mobsby joined the company in 1982 in the United Kingdom, where he fulfilled a number of roles in the marketing area on both established brands and in new product development. From January 1988 to mid 1990, he worked in the cereal marketing group of Kellogg USA, his last position being Vice President of Marketing. From 1990 to 1993, he was President and Director General of Kellogg France & Benelux, before returning to the United Kingdom as Regional Director, Kellogg Europe and Managing Director, Kellogg Company of Great Britain Limited. He was subsequently appointed Vice President, Marketing, Innovation and Trade Strategy, Kellogg Europe. He was Vice President, Global Marketing from February to October 2000.

 

Paul T. Norman

  45

Senior Vice President, Kellogg Company

President, Kellogg International

Paul Norman was appointed President, Kellogg International in August 2008. Mr. Norman joined Kellogg’s U.K. sales organization in 1987. He was

 

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promoted to director, marketing, Kellogg de Mexico in January 1997; to Vice President, Marketing, Kellogg USA in February 1999; and to President, Kellogg Canada Inc. in December 2000. In February 2002, he was promoted to Managing Director, United Kingdom/Republic of Ireland and to Vice President in August 2003. He was appointed President, U.S. Morning Foods in September 2004. In December 2005, Mr. Norman was promoted to Senior Vice President.

 

Gary H. Pilnick

  45

Senior Vice President, General Counsel,

Corporate Development and Secretary

Mr. Pilnick was appointed Senior Vice President, General Counsel and Secretary in August 2003 and assumed responsibility for Corporate Development in June 2004. He joined Kellogg as Vice President — Deputy General Counsel and Assistant Secretary in September 2000 and served in that position until August 2003. Before joining Kellogg, he served as Vice President and Chief Counsel of Sara Lee Branded Apparel and as Vice President and Chief Counsel, Corporate Development and Finance at Sara Lee Corporation.

 

Dennis W. Shuler

  54

Senior Vice President, Global Human Resources

Mr. Shuler joined Kellogg on February 18, 2010. In 2009, Mr. Shuler served as President of Core Strengths Management Consulting. From April 2008 to April 2009, he was Executive Vice President and Chief Human Resources Officer at The Walt Disney Company. Prior to that, Mr. Shuler served in progressively responsible human resources positions over a period of 23 years at Procter & Gamble Company in the United States and the United Kingdom, serving as Vice-President of the P&G Beauty global business unit from July 2001 and the Vice President of P&G Beauty and Health & Well Being global business units from July 2006 through March 2008.

 

Alan R. Andrews

  54

Vice President and Corporate Controller

Mr. Andrews joined Kellogg Company in 1982. He served in various financial roles before relocating to China as general manager of Kellogg China in 1993. He subsequently served in several leadership innovation and finance roles before being promoted to Vice President, International Finance, Kellogg International in 2000. In 2002, he was appointed to Assistant Corporate Controller and assumed his current position in June 2004.

Availability of Reports; Website Access; Other Information.  Our internet address is http://www.kelloggcompany.com. Through “Investor Relations” — “Financials” — “SEC Filings” on our home page, we make available free of charge our proxy statements, our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, SEC Forms 3, 4 and 5 and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Our reports filed with the Securities and Exchange Commission are also made available to read and copy at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information about the Public Reference Room by contacting the SEC at 1-800-SEC-0330. Reports filed with the SEC are also made available on its website at www.sec.gov.

Copies of the Corporate Governance Guidelines, the Charters of the Audit, Compensation and Nominating and Governance Committees of the Board of Directors, the Code of Conduct for Kellogg Company directors and Global Code of Ethics for Kellogg Company employees (including the chief executive officer, chief financial officer and corporate controller) can also be found on the Kellogg Company website. Any amendments or waivers to the Global Code of Ethics applicable to the chief executive officer, chief financial officer and corporate controller can also be found in the “Investor Relations” section of the Kellogg Company website. Shareowners may also request a free copy of these documents from: Kellogg Company, P.O. Box CAMB, Battle Creek, Michigan 49086-1986 (phone: (800) 961-1413), Investor Relations Department at that same address (phone: (269) 961-2800) or investor.relations@kellogg.com.

Forward-Looking Statements.  This Report contains “forward-looking statements” with projections concerning, among other things, our strategy, financial principles, and plans; initiatives, improvements and growth; sales, gross margins, advertising, promotion, merchandising, brand building, operating profit, and earnings per share; innovation; investments; capital expenditures; asset write-offs and expenditures and costs related to productivity or efficiency initiatives; the impact of accounting changes and significant accounting estimates; our ability to meet interest and debt principal repayment obligations; minimum contractual obligations; future common stock repurchases or debt reduction; effective income tax rate; cash flow and core working capital improvements; interest expense; commodity and energy prices; and employee benefit plan costs and funding. Forward-looking statements include predictions of future results or activities and may contain the words “expect,” “believe,” “will,” “will deliver,” “anticipate,” “project,” “should,” or words or phrases of similar meaning. For example, forward-looking statements are found in this Item 1 and in several sections of Management’s Discussion and Analysis. Our actual results or activities may differ materially from these predictions. Our future results

 

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could be affected by a variety of factors, including the impact of competitive conditions; the effectiveness of pricing, advertising, and promotional programs; the success of innovation, renovation and new product introductions; the recoverability of the carrying value of goodwill and other intangibles; the success of productivity improvements and business transitions; commodity and energy prices; labor costs; disruptions or inefficiencies in supply chain; the availability of and interest rates on short-term and long-term financing; actual market performance of benefit plan trust investments; the levels of spending on systems initiatives, properties, business opportunities, integration of acquired businesses, and other general and administrative costs; changes in consumer behavior and preferences; the effect of U.S. and foreign economic conditions on items such as interest rates, statutory tax rates, currency conversion and availability; legal and regulatory factors including changes in advertising and labeling laws and regulations; the ultimate impact of product recalls; business disruption or other losses from war, terrorist acts, or political unrest and the risks and uncertainties described in Item 1A below. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to publicly update them.

ITEM 1A. RISK FACTORS

In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect our business, financial condition and results of operations. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations and financial condition.

Our results may be materially and adversely impacted as a result of increases in the price of raw materials, including agricultural commodities, fuel and labor.

Agricultural commodities, including corn, wheat, soybean oil, sugar and cocoa, are the principal raw materials used in our products. Cartonboard, corrugated, and plastic are the principal packaging materials used by us. The cost of such commodities may fluctuate widely due to government policy and regulation, weather conditions, climate change or other unforeseen circumstances. To the extent that any of the foregoing factors affect the prices of such commodities and we are unable to increase our prices or adequately hedge against such changes in prices in a manner that offsets such changes, the results of our operations could be materially and adversely affected. In addition, we use derivatives to hedge price risk associated with forecasted purchases of raw materials. Our hedged price could exceed the spot price on the date of purchase, resulting in an unfavorable impact on both gross margin and net earnings.

Cereal processing ovens at major domestic and international facilities are regularly fueled by natural gas or propane, which are obtained from local utilities or other local suppliers. Short-term stand-by propane storage exists at several plants for use in case of interruption in natural gas supplies. Oil may also be used to fuel certain operations at various plants. In addition, considerable amounts of diesel fuel are used in connection with the distribution of our products. The cost of fuel may fluctuate widely due to economic and political conditions, government policy and regulation, war, or other unforeseen circumstances which could have a material adverse effect on our consolidated operating results or financial condition.

A shortage in the labor pool or other general inflationary pressures or changes in applicable laws and regulations could increase labor cost, which could have a material adverse effect on our consolidated operating results or financial condition.

Additionally, our labor costs include the cost of providing benefits for employees. We sponsor a number of defined benefit plans for employees in the United States and various foreign locations, including pension, retiree health and welfare, active health care, severance and other postemployment benefits. We also participate in a number of multiemployer pension plans for certain of our manufacturing locations. Our major pension plans and U.S. retiree health and welfare plans are funded with trust assets invested in a globally diversified portfolio of equity securities with smaller holdings of bonds, real estate and other investments. The annual cost of benefits can vary significantly from year to year and is materially affected by such factors as changes in the assumed or actual rate of return on major plan assets, a change in the weighted-average discount rate used to measure obligations, the rate or trend of health care cost inflation, and the outcome of collectively-bargained wage and benefit agreements.

Our operations face significant foreign currency exchange rate exposure which could negatively impact our operating results.

We hold assets and incur liabilities, earn revenue and pay expenses in a variety of currencies other than the U.S. dollar, including the British pound, euro, Australian dollar, Canadian dollar, Venezuelan bolivar fuerte, Russian ruble and Mexican peso. Because our consolidated financial statements are presented in U.S. dollars, we must translate our assets, liabilities, revenue and expenses into U.S. dollars at then-applicable exchange rates. Consequently, changes in the value of the U.S. dollar may negatively affect the value of these items in our consolidated financial statements, even if their value has not changed in their original currency.

Concerns with the safety and quality of food products could cause consumers to avoid certain food products or ingredients.

We could be adversely affected if consumers lose confidence in the safety and quality of certain food

 

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products or ingredients, or the food safety system generally. Adverse publicity about these types of concerns, whether or not valid, may discourage consumers from buying our products or cause production and delivery disruptions.

If our food products become adulterated or misbranded, we might need to recall those items and may experience product liability if consumers are injured as a result.

Selling food products involves a number of legal and other risks, including product contamination, spoilage, product tampering or other adulteration. We may need to recall some of our products if they become adulterated or misbranded. We may also be liable if the consumption of any of our products causes injury, illness or death. A widespread product recall or market withdrawal could result in significant losses due to their costs, the destruction of product inventory, and lost sales due to the unavailability of product for a period of

time. For example, in January 2009, we initiated a recall of certain Austin and Keebler branded peanut butter sandwich crackers and certain Famous Amos and Keebler branded peanut butter cookies as a result of potential contamination of ingredients at a supplier’s facility. The recall was expanded in late January and February to include Bear Naked, Kashi and Special K products impacted by that same supplier’s ingredients. The costs of the recall negatively impacted gross margin and operating profit in fiscal 2008 and 2009. We could also suffer losses from a significant product liability judgment against us. A significant product recall or product liability case could also result in adverse publicity, damage to our reputation, and a loss of consumer confidence in our food products, which could have a material adverse effect on our business results and the value of our brands. Moreover, even if a product liability or consumer fraud claim is meritless, does not prevail or is not pursued, the negative publicity surrounding assertions against our Company and our products or processes could adversely affect our reputation or brands.

Disruption of our supply chain could have an adverse effect on our business, financial condition and results of operations.

Our ability, including manufacturing or distribution capabilities, and that of our suppliers, business partners and contract manufacturers, to make, move and sell products is critical to our success. Damage or disruption to our or their manufacturing or distribution capabilities due to weather, natural disaster, fire or explosion, terrorism, pandemics, strikes, repairs or enhancements at our facilities, or other reasons, could impair our ability to manufacture or sell our products. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition and results of operations, as well as require additional resources to restore our supply chain.

Changes in tax, environmental, food quality and safety or other regulations or failure to comply with existing licensing, trade, food quality and safety and other regulations and laws could have a material adverse effect on our consolidated financial condition.

Our activities, both in and outside of the United States, are subject to regulation by various federal, state, provincial and local laws, regulations and government agencies, including the U.S. Food and Drug Administration, U.S. Federal Trade Commission, the U.S. Departments of Agriculture, Commerce and Labor, as well as similar and other authorities of the European Union, International Accords and Treaties and others, including voluntary regulation by other bodies.

The manufacturing, marketing and distribution of food products are subject to governmental regulation that is becoming increasingly burdensome. Those regulations control such matters as food quality and safety, ingredients, advertising, relations with distributors and retailers, health and safety and the environment. We are also regulated with respect to matters such as licensing requirements, trade and pricing practices, tax and environmental matters. The need to comply with new or revised tax, environmental, food quality and safety or other laws or regulations, or new or changed interpretations or enforcement of existing laws or regulations, may have a material adverse effect on our business and results of operations. Further, if we are found to be out of compliance with applicable laws and regulations in these areas, we could be subject to civil remedies, including fines, injunctions, or recalls, as well as potential criminal sanctions, any of which could have a material adverse effect on our business.

If we pursue strategic acquisitions, divestitures or joint ventures, we may not be able to successfully consummate favorable transactions or successfully integrate acquired businesses.

From time to time, we may evaluate potential acquisitions, divestitures or joint ventures that would further our strategic objectives. With respect to acquisitions, we may not be able to identify suitable candidates, consummate a transaction on terms that are favorable to us, or achieve expected returns and other benefits as a result of integration challenges. With respect to proposed divestitures of assets or businesses, we may encounter difficulty in finding acquirers or alternative exit strategies on terms that are favorable to us, which could delay the accomplishment of our strategic objectives, or our divesture activities may require us to recognize impairment charges. Companies or operations acquired or joint ventures created may not be profitable or may not achieve sales levels and profitability that justify the investments made. Our

 

7


corporate development activities may present financial and operational risks, including diversion of management attention from existing core businesses, integrating or separating personnel and financial and other systems, and adverse effects on existing business relationships with suppliers and customers. Future acquisitions could also result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses, which could adversely affect our results of operations and financial condition.

Our consolidated financial results and demand for our products are dependent on the successful development of new products and processes.

There are a number of trends in consumer preferences which may impact us and the industry as a whole. These include changing consumer dietary trends and the availability of substitute products.

Our success is dependent on anticipating changes in consumer preferences and on successful new product and process development and product relaunches in response to such changes. We aim to introduce products or new or improved production processes on a timely basis in order to counteract obsolescence and decreases in sales of existing products. While we devote significant focus to the development of new products and to the research, development and technology process functions of our business, we may not be successful in developing new products or our new products may not be commercially successful. Our future results and our ability to maintain or improve our competitive position will depend on our capacity to gauge the direction of our key markets and upon our ability to successfully identify, develop, manufacture, market and sell new or improved products in these changing markets.

We operate in the highly competitive food industry.

We face competition across our product lines, including ready-to-eat cereals and convenience foods, from other companies which have varying abilities to withstand changes in market conditions. Some of our competitors have substantial financial, marketing and other resources, and competition with them in our various markets and product lines could cause us to reduce prices, increase capital, marketing or other expenditures, or lose category share, any of which could have a material adverse effect on our business and financial results. Category share and growth could also be adversely impacted if we are not successful in introducing new products.

Potential liabilities and costs from litigation could adversely affect our business.

There is no guarantee that the Company will be successful in defending itself in civil, criminal or regulatory actions, including under environmental, food quality and safety, and environmental laws and regulations, or in asserting its rights under various laws. In addition, the Company could incur substantial costs and fees in defending itself or in asserting its rights in these actions or meeting new legal requirements. The costs and other effects of potential and pending litigation and administrative actions against the Company, and new legal requirements, cannot be determined with certainty and may differ from expectations.

We have a substantial amount of indebtedness.

We have indebtedness that is substantial in relation to our shareholders’ equity. As of January 2, 2010, we had total debt of approximately $4.9 billion and total equity of $2.3 billion.

Our substantial indebtedness could have important consequences, including:

 

 

impairing the ability to obtain additional financing for working capital, capital expenditures or general corporate purposes, particularly if the ratings assigned to our debt securities by rating organizations were revised downward.

 

 

A downgrade in our credit ratings, particularly our short-term credit rating, would likely reduce the amount of commercial paper we could issue, increase our commercial paper borrowing costs, or both;

 

 

restricting our flexibility in responding to changing market conditions or making us more vulnerable in the event of a general downturn in economic conditions or our business;

 

 

requiring a substantial portion of the cash flow from operations to be dedicated to the payment of principal and interest on our debt, reducing the funds available to us for other purposes such as expansion through acquisitions, marketing spending and expansion of our product offerings; and

 

 

causing us to be more leveraged than some of our competitors, which may place us at a competitive disadvantage.

Our ability to make scheduled payments or to refinance our obligations with respect to indebtedness will depend on our financial and operating performance, which in turn, is subject to prevailing economic conditions, the availability of, and interest rates on, short-term financing, and financial, business and other factors beyond our control.

Our performance is affected by general economic and political conditions and taxation policies.

Customer and consumer demand for our products may be impacted by recession, financial and credit market disruptions, or other economic downturns in the United States or other nations. Our results in the

 

8


past have been, and in the future may continue to be, materially affected by changes in general economic and political conditions in the United States and other countries, including the interest rate environment in which we conduct business, the financial markets through which we access capital and currency, political unrest and terrorist acts in the United States or other countries in which we carry on business.

The enactment of or increases in tariffs, including value added tax, or other changes in the application of existing taxes, in markets in which we are currently active or may be active in the future, or on specific products that we sell or with which our products compete, may have an adverse effect on our business or on our results of operations.

We may be unable to maintain our profit margins in the face of a consolidating retail environment. In addition, the loss of one of our largest customers could negatively impact our sales and profits.

Our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 21% of consolidated net sales during 2009, comprised principally of sales within the United States. At January 2, 2010, approximately 17% of our consolidated receivables balance and 26% of our U.S. receivables balance was comprised of amounts owed by Wal-Mart Stores, Inc. and its affiliates. No other customer accounted for greater than 10% of net sales in 2009. During 2009, our top five customers, collectively, including Wal-Mart, accounted for approximately 34% of our consolidated net sales and approximately 44% of U.S. net sales. As the retail grocery trade continues to consolidate and mass marketers become larger, our large retail customers may seek to use their position to improve their profitability through improved efficiency, lower pricing and increased promotional programs. If we are unable to use our scale, marketing expertise, product innovation and category leadership positions to respond, our profitability or volume growth could be negatively affected. The loss of any large customer for an extended length of time could negatively impact our sales and profits.

An impairment in the carrying value of goodwill or other acquired intangibles could negatively affect our consolidated operating results and net worth.

The carrying value of goodwill represents the fair value of acquired businesses in excess of identifiable assets and liabilities as of the acquisition date. The carrying value of other intangibles represents the fair value of trademarks, trade names, and other acquired intangibles as of the acquisition date. Goodwill and other acquired intangibles expected to contribute indefinitely to our cash flows are not amortized, but must be evaluated by management at least annually for impairment. If carrying value exceeds current fair value, the intangible is considered impaired and is reduced to fair value via a charge to earnings. Events and conditions which could result in an impairment include changes in the industries in which we operate, including competition and advances in technology; a significant product liability or intellectual property claim; or other factors leading to reduction in expected sales or profitability. Should the value of one or more of the acquired intangibles become impaired, our consolidated earnings and net worth may be materially adversely affected.

As of January 2, 2010, the carrying value of intangible assets totaled approximately $5.1 billion, of which $3.6 billion was goodwill and $1.5 billion represented trademarks, tradenames, and other acquired intangibles compared to total assets of $11.2 billion and total equity of $2.3 billion.

Economic downturns could limit consumer demand for our products.

Retailers are increasingly offering private label products that compete with our products. Consumers’ willingness to purchase our products will depend upon our ability to offer products that appeal to consumers at the right price. It is also important that our products are perceived to be of a higher quality than less expensive alternatives. If the difference in quality between our products and those of store brands narrows, or if such difference in quality is perceived to have narrowed, then consumers may not buy our products. Furthermore, during periods of economic uncertainty, consumers tend to purchase more private label or other economy brands, which could reduce sales volumes of our higher margin products or there could be a shift in our product mix to our lower margin offerings. If we are not able to maintain or improve our brand image, it could have a material affect on our market share and our profitability.

We may not achieve our targeted cost savings and efficiencies from cost reduction initiatives.

Our success depends in part on our ability to be an efficient producer in a highly competitive industry. We have invested a significant amount in capital expenditures to improve our operational facilities. Ongoing operational issues are likely to occur when carrying out major production, procurement, or logistical changes and these, as well as any failure by us to achieve our planned cost savings and efficiencies, could have a material adverse effect on our business and consolidated financial position and on the consolidated results of our operations and profitability.

Technology failures could disrupt our operations and negatively impact our business.

We increasingly rely on information technology systems to process, transmit, and store electronic information. For example, our production and

 

9


distribution facilities and inventory management utilize information technology to increase efficiencies and limit costs. Furthermore, a significant portion of the communications between our personnel, customers, and suppliers depends on information technology. Like other companies, our information technology systems

may be vulnerable to a variety of interruptions due to events beyond our control, including, but not limited to, natural disasters, terrorist attacks, telecommunications failures, computer viruses, hackers, and other security issues. We have technology security initiatives and disaster recovery plans in place or in process to mitigate our risk to these vulnerabilities, but these measures may not be adequate.

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products and brands.

We consider our intellectual property rights, particularly and most notably our trademarks, but also including patents, trade secrets, copyrights and licensing agreements, to be a significant and valuable aspect of our business. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as licensing agreements, third party nondisclosure and assignment agreements and policing of third party misuses of our intellectual property. Our failure to obtain or adequately protect our trademarks, products, new features of our products, or our technology, or any change in law or other changes that serve to lessen or remove the current legal protections of our intellectual property, may diminish our competitiveness and could materially harm our business.

We may be unaware of intellectual property rights of others that may cover some of our technology, brands or products. Any litigation regarding patents or other intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Third party claims of intellectual property infringement might also require us to enter into costly license agreements. We also may be subject to significant damages or injunctions against development and sale of certain products.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our corporate headquarters and principal research and development facilities are located in Battle Creek, Michigan.

We operated, as of February 26, 2010, manufacturing plants and distribution and warehousing facilities totaling more than 30 million square feet of building area in the United States and other countries. Our plants have been designed and constructed to meet our specific production requirements, and we periodically invest money for capital and technological improvements. At the time of its selection, each location was considered to be favorable, based on the location of markets, sources of raw materials, availability of suitable labor, transportation facilities, location of our other plants producing similar products, and other factors. Our manufacturing facilities in the United States include four cereal plants and warehouses located in Battle Creek, Michigan; Lancaster, Pennsylvania; Memphis, Tennessee; and Omaha, Nebraska and other plants in San Jose, California; Atlanta, Augusta, Columbus, and Rome, Georgia; Chicago, Illinois; Seelyville, Indiana, Kansas City, Kansas; Florence, Louisville, and Pikeville, Kentucky; Grand Rapids and Wyoming, Michigan; Blue Anchor, New Jersey; Cary and Charlotte, North Carolina; Cincinnati, West Jefferson, and Zanesville, Ohio; Muncy, Pennsylvania; Rossville, Tennessee; Clearfield, Utah; and Allyn, Washington.

Outside the United States, we had, as of February 26, 2010, additional manufacturing locations, some with warehousing facilities, in Australia, Brazil, Canada, China, Colombia, Ecuador, Germany, Great Britain, India, Japan, Mexico, Russia, South Africa, South Korea, Spain, Thailand, and Venezuela.

We generally own our principal properties, including our major office facilities, although some manufacturing facilities are leased, and no owned property is subject to any major lien or other encumbrance. Distribution facilities (including related warehousing facilities) and offices of non-plant locations typically are leased. In general, we consider our facilities, taken as a whole, to be suitable, adequate, and of sufficient capacity for our current operations.

ITEM 3. LEGAL PROCEEDINGS

We are subject to various legal proceedings, claims, and governmental inspections or investigations arising out of our business which cover matters such as general commercial, governmental regulations, antitrust and trade regulations, product liability, environmental, intellectual property, employment and other actions. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on our financial position or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

 

10


PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Information on the market for our common stock, number of shareowners and dividends is located in Note 16 within Notes to the Consolidated Financial Statements.

 

On February 5, 2009, the Board of Directors authorized the repurchase of $650 million of Kellogg common stock during 2009 for general corporate purposes and to offset issuances for employee benefit programs. During the quarter ended January 2, 2010, the Company did not acquire any shares of its common stock. During 2009, the Company spent $187 million to repurchase 4 million shares. The unused portion of the 2009 authorization, amounting to $463 million, was rolled over and is available to be executed in 2010. On October 23, 2009, the Board of Directors authorized an additional stock repurchase program of up to $650 million for 2010.

 

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ITEM 6. SELECTED FINANCIAL DATA

Kellogg Company and Subsidiaries

Selected Financial Data

 

(millions, except per share data and number of employees)    2009      2008      2007      2006      2005  

Operating trends (a)

              

Net sales

   $ 12,575       $ 12,822       $ 11,776       $ 10,907       $ 10,177   

Gross profit as a % of net sales

     42.9%         41.9%         44.0%         44.2%         44.9%   

Depreciation

     381         374         364         351         390   

Amortization

     3         1         8         2         2   

Advertising expense

     1,091         1,076         1,063         916         858   

Research and development expense

     181         181         179         191         181   

Operating profit

     2,001         1,953         1,868         1,766         1,750   

Operating profit as a % of net sales

     15.9%         15.2%         15.9%         16.2%         17.2%   

Interest expense

     295         308         319         307         300   

Net income attributable to Kellogg Company

     1,212         1,148         1,103         1,004         980   

Average shares outstanding:

              

Basic

     382         382         396         397         412   

Diluted

     384         385         400         400         416   

Per share amounts:

              

Basic

     3.17         3.01         2.79         2.53         2.38   

Diluted

     3.16         2.99         2.76         2.51         2.36   

Cash flow trends

              

Net cash provided by operating activities

   $ 1,643       $ 1,267       $ 1,503       $ 1,410       $ 1,143   

Capital expenditures

     377         461         472         453         374   

Net cash provided by operating activities reduced by capital expenditures (b)

     1,266         806         1,031         957         769   

Net cash used in investing activities

     (370      (681      (601      (445      (415

Net cash used in financing activities

     (1,182      (780      (788      (789      (905

Interest coverage ratio (c)

     8.0         7.5         7.0         6.9         7.1   

Capital structure trends

              

Total assets

   $ 11,200       $ 10,946       $ 11,397       $ 10,714       $ 10,575   

Property, net

     3,010         2,933         2,990         2,816         2,648   

Short-term debt

     45         1,388         1,955         1,991         1,195   

Long-term debt

     4,835         4,068         3,270         3,053         3,703   

Total Kellogg Company equity (d)

     2,272         1,448         2,526         2,069         2,284   

Share price trends

              

Stock price range

   $ 36-54       $ 40-59       $ 49-57       $ 42-51       $ 42-47   

Cash dividends per common share

     1.430         1.300         1.202         1.137         1.060   

Number of employees

     30,949         32,394         26,494         25,856         25,606   

 

(a) Fiscal year 2008 contains a 53rd shipping week. Refer to Note 1 within Notes to Consolidated Financial Statements.

 

(b) The Company uses this non-GAAP financial measure to focus management and investors on the amount of cash available for debt repayment, dividend distribution, acquisition opportunities, and share repurchase, which is reconciled above.

 

(c) Interest coverage ratio is calculated based on income before interest expense, income taxes, depreciation and amortization, divided by interest expense.

 

(d) 2008 change due primarily to currency translation adjustments of ($431) and net experience losses in postretirement and postemployment benefit plans of ($865).

 

12

 


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Kellogg Company and Subsidiaries

 

RESULTS OF OPERATIONS

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 8 of this report.

Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles, and veggie foods. Kellogg products are manufactured and marketed globally. We currently manage our operations in four geographic operating segments, comprised of North America and the three International operating segments of Europe, Latin America, and Asia Pacific.

We manage our Company for sustainable performance defined by our long-term annual growth targets. These targets are low single-digit (1 to 3%) for internal net sales, mid single-digit (4 to 6%) for internal operating profit, and high single-digit (7 to 9%) for diluted net earnings per share (EPS) on a currency neutral basis. See Foreign currency translation section for our definition of currency neutral EPS.

For our full year 2009, we were at the high end of our long-term annual net sales target with internal growth of 3%. On a reported basis, net sales declined by 2%. Consolidated internal operating profit increased 10%, exceeding our long-term annual growth target. Reported operating profit grew 2%. Diluted EPS grew 13% on a currency neutral basis, exceeding our long-term annual growth target of 7 to 9%. Reported EPS was $3.16, an increase of 6% over last year’s $2.99.

 

Consolidated results

(dollars in millions, except per share data)

  2009    2008    2007

Net sales

  $ 12,575    $ 12,822    $ 11,776

Net sales growth:

  As reported     –1.9%      8.9%      8.0%
    Internal (a)     3.0%      5.4%      5.4%

Operating profit

  $ 2,001    $ 1,953    $ 1,868

Operating profit growth:

  As reported     2.5%      4.5%      5.8%
    Internal (a)     10.3%      4.2%      3.1%

Diluted net earnings per share (EPS)

  $ 3.16    $ 2.99    $ 2.76

EPS growth

    6%      8%      10%

Currency neutral diluted EPS growth (b)

    13%      8%      7%

 

(a)

Internal net sales and operating profit for 2009 exclude the impact of currency and acquisitions. Internal net sales and operating profit growth for 2008 exclude the impact of currency, a 53rd shipping week and acquisitions. Internal net sales and operating profit for 2007 excludes the impact of currency. Internal net sales and operating profit growth is a non-GAAP financial measure which is further discussed and reconciled to GAAP basis growth on page 16.

 

(b) See the section entitled Foreign currency translation for discussion and reconciliation of the non-GAAP financial measure.

In combination with an attractive dividend yield, we believe this profitable growth has and will continue to provide a strong total return to our shareholders. We believe we can achieve this sustainable growth through a strategy focused on growing our cereal business, expanding our snacks business, and pursuing selected growth opportunities. We support our business strategy with operating principles that emphasize profit-rich, sustainable sales growth, as well as cash flow and return on invested capital. We believe our steady earnings growth, strong cash flow, and continued investment during a multi-year period of economic uncertainty demonstrates the strength and flexibility of our business model.

 

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Net sales and operating profit

2009 compared to 2008

The following table provides an analysis of net sales and operating profit performance for 2009 versus 2008:

 

(dollars in millions)   North
America
  Europe   Latin
America
 

Asia

Pacific

(a)

  Corporate     Consolidated

2009 net sales

  $8,510   $ 2,361   $ 963   $ 741   $—      $12,575

2008 net sales

  $8,457   $ 2,619   $ 1,030   $ 716   $—      $12,822

% change — 2009 vs. 2008:

           

Volume (tonnage) (b)

  –.7%   –1.6%   1.2%   –1.3%        –.7%

Pricing/mix

  3.5%   3.2%   5.6%   6.3%        3.7%

Subtotal — internal business

  2.8%   1.6%   6.8%   5.0%        3.0%

Acquisitions (c)

  .1%   .3%     3.7%        .3%

Shipping day differences (d)

  –1.8%   –1.1%   –.5%   –.9%        –1.5%

Foreign currency impact

  –.5%   –10.6%   –12.9%   –4.3%        –3.7%

Total change

  .6%   –9.8%   –6.6%   3.5%        –1.9%
           
(dollars in millions)   North
America
  Europe   Latin
America
 

Asia

Pacific

(a)

  Corporate     Consolidated

2009 operating profit

  $1,569   $ 348   $ 179   $ 86   $(181   $ 2,001

2008 operating profit

  $1,447   $ 390   $ 209   $ 92   $(185   $ 1,953

% change — 2009 vs. 2008:

           

Internal business

  11.4%   7.0%   –2.0%   13.5%        10.3%

Acquisitions (c)

        –8.4%        –.4%

Shipping day differences (d)

  –2.4%   –1.3%   .9%   –.8%   1.8%      –1.8%

Foreign currency impact

  –.5%   –16.5%   –13.1%   –10.5%        –5.6%

Total change

  8.5%   –10.8%   –14.2%   –6.2%   1.8%      2.5%

 

(a) Includes Australia, Asia and South Africa.

 

(b) We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments.

 

(c) Impact of results for the year-to-date period ended January 2, 2010 from the acquisitions of United Bakers, Navigable Foods, Specialty Cereal and certain assets and liabilities of IndyBake.

 

(d)

Impact of 53rd shipping week in 2008.

Our consolidated reported net sales were down compared to last year, driven by a negative impact from foreign currency translation and an extra shipping week in 2008. Excluding this negative impact, internal net sales grew by 3%, lapping last year’s strong 5% growth. While our overall volume declined, we achieved internal sales growth driven by a particularly strong year in retail cereal and a solid year in retail snacks resulting from our pricing and mix. There were several factors contributing to the volume decline. In North America, we experienced a supply disruption in our waffle plants. In both Russia and China we are moving our businesses away from lower margin products and going to higher margin branded products which resulted in a decline in volume during the year.

Our North America operating segment had internal net sales growth of almost 3% against a difficult 6% comparative in the year ago period. We experienced growth in retail cereal of 4% and 3% growth in retail snacks, which includes cookies, crackers, toaster pastries, cereal bars and fruit snacks. Weakness in frozen and specialty channels, which includes frozen foods, food service and vending, dampened net sales for the year, with a decline in net sales of 1%.

 

Cereal continues to be a strong category where we achieved volume growth during the year. It responds well to innovation and advertising. We are committed to providing nutritious food to our consumers and introduced Froot Loops® and Apple Jacks® with fiber in August of 2009. Our business is focused on driving our top 8 brands as well as Kashi® cereals.

We experienced broad based growth in retail snacks, with sales growth of 3%. Pop-Tarts® continues to perform well and is the category leader in North America toaster pastries. A strong performance by Cheez-It®, as well as innovation, drove growth in crackers. Cookies posted a slight gain for the year led by our recently acquired Mother’s® brand cookies. Our growth was negatively impacted by heavy competitor activity. Our best performing category within retail snacks was wholesome snacks. The introduction of Fiber Plus®, Special K® Chocolaty Pretzel and Cinnabon® bars drove growth in this category

Our frozen and specialty channels business was down 1%, experiencing a tough year due to a few discrete issues. Our food service business is mostly non-commercial, serving institutions such as schools, hospitals and prisons. This sector of the industry was not immediately impacted by the economic downturn that started in 2008. While we are seeing a recovery, we believe it will be slower than the commercial sectors such and hotels and restaurants, continuing to impact us until mid-2010. We have also been experiencing a supply disruption in our waffle facilities. We have been making improvements in our facilities and are working with regulatory agencies. A combination of extensive enhancements and repairs at our facilities and a flood at one facility, significantly impacted production in the second-half of the year. While our plants are operational, they are not running at their previous level of capacity. Demand continues to exceed supply. We are exploring ways to increase capacity, including investing additional capital, but expect this situation will impact our net sales in 2010. This impact is included in our 2010 guidance.

Our International operating segments collectively achieved net sales growth of 3% on an internal basis. Europe’s internal net sales increased 2% year-over-year. Europe was a tough environment for us in 2009. We encountered some retailer disputes earlier in the year that were resolved in the second half of the year, helping us to achieve cereal volume growth. Latin America’s internal net sales growth was 7% attributable to both volume and price increases driven by retail cereal in Mexico and Venezuela. Internal net sales in Asia Pacific grew 5%, driven by strong cereal performances in Australia and India.

Our consolidated operating profit was strong, increasing by 10% on an internal basis and by 2% on a reported basis. Reported operating profit in each of our operating segments was negatively impacted by foreign exchange as well as the absence of a 53 rd week in 2009. In 2009, we continued to experience cost

 

14


pressures, increased our spending on up-front costs, and invested in advertising. We were able to more than offset these increased costs by savings from our cost reduction and productivity initiatives as well as pricing and mix. During the full-year of 2009, our up-front costs were $138 million, which were $63 million higher than the previous year. Up-front costs represent both exit or disposal activities as well as other cost reduction initiatives.

North America’s internal operating profit growth of 11% was driven by price and savings from our cost reduction initiatives, which was partially offset by significantly higher up-front costs and increased advertising. Up-front costs reduced North America’s operating profit by 4%. Europe’s internal operating profit increased 7% benefiting from media deflation and operating efficiencies while absorbing higher up-front costs which reduced operating profit by 3%. Internal operating profit decreased 2% in Latin America due to significantly higher material costs and increased advertising. Internal operating profit growth in Asia Pacific was 14% due to sales growth, while reported operating profit was negatively impacted by the acquisition of Navigable Foods. For further information on our acquisitions, see Note 2 within Notes to Consolidated Financial Statements.

2008 compared to 2007

The following tables provide an analysis of net sales and operating profit performance for 2008 versus 2007:

 

(dollars in millions)   North
America
  Europe   Latin
America
 

Asia
Pacific

(a)

  Corporate     Consolidated

2008 net sales

  $ 8,457   $ 2,619   $ 1,030   $ 716   $      $ 12,822

2007 net sales

  $ 7,786   $ 2,357   $ 984   $ 649   $      $ 11,776

% change — 2008 vs. 2007:

           

Volume (tonnage) (b)

    1.3%     –.2%     –2.6%     6.3%            .9%

Pricing/mix

    4.5%     3.9%     6.9%     1.8%            4.5%

Subtotal — internal business

    5.8%     3.7%     4.3%     8.1%            5.4%

Acquisitions (c)

    .9%     5.5%         3.4%            1.8%

Shipping day differences (d)

    1.9%     1.2%     .5%     1.0%            1.7%

Foreign currency impact

        .7%     –.1%     –2.2%           

Total change

    8.6%     11.1%     4.7%     10.3%            8.9%
           
(dollars in millions)   North
America
  Europe   Latin
America
  Asia
Pacific (a)
  Corporate     Consolidated

2008 operating profit

  $ 1,447   $ 390   $ 209   $ 92   $ (185   $ 1,953

2007 operating profit

  $ 1,345   $ 397   $ 213   $ 88   $ (175   $ 1,868

% change — 2008 vs. 2007:

           

Internal business

    5.9%     –.6%     –1.5%     11.0%     –2.8%        4.2%

Acquisitions (c)

    –.8%     –.6%         –6.2%            –1.0%

Shipping day differences (d)

    2.5%     1.2%     –.9%     .8%     –1.9%        1.8%

Foreign currency impact

    –.1%     –1.9%     .4%     –1.8%            –.5%

Total change

    7.5%     –1.9%     –2.0%     3.8%     –4.7%        4.5%

 

(a) Includes Australia, Asia and South Africa.

 

(b) We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments.

 

(c) Impact of results for the year-to-date period ended January 3, 2009 from the acquisitions of United Bakers, Bear Naked, Navigable Foods, Specialty Cereals and certain assets and liabilities of the Wholesome & Hearty Foods Company and IndyBake.

 

(d)

Impact of 53rd shipping week in 2008.

 

During 2008, our consolidated reported net sales increased almost 9% driven by our North America business with increases in both volume and price/mix for the year. Internal net sales grew over 5%, building on a 5% rate of internal growth during 2007. We had a fifty-third week in our 2008 fiscal year which contributed almost 2% to our reported growth over the prior year as did our acquisitions. Management has estimated the pro forma effect on the Company’s results of operations as though these business combinations had been completed at the beginning of either 2008 or 2007 would have been immaterial. Successful innovation, brand-building (advertising and consumer promotion) investment as well as our price increases continued to drive growth. Declines in volume in both Europe and Latin America were more than offset by growth in pricing/mix due to our price increases. Asia Pacific had a particularly strong year experiencing growth of 8% driven by cereal sales across the operating segment.

For 2008, our North America operating segment reported a net sales increase of almost 9% with internal net sales growth of 6%. The growth was broad based and driven by our price realization and strong innovation. The major product brands grew as follows: retail cereal +3%; retail snacks (cookies, crackers, toaster pastries, cereal bars, and fruit snacks) +6%; frozen and specialty channels (frozen foods, food service and vending) +9%. While retail cereal grew 3% for the year, we had a relatively soft share performance in the fourth quarter facing aggressive price-based incentives from our competitors. In addition, while we estimate our consumption was up 2% across all channels, reductions in trade inventory also adversely affected shipments. As a result, our fourth quarter internal net sales declined by 3% which was up against a tough comparable of 8% growth in the prior year. Our snacks business grew 6% in 2008 on top of 7% growth last year. Our growth came from volume, price increases, and successful innovations such as Townhouse Flipsides and Cheez-It Duoz. We saw net sales growth in all product categories — toaster pastries, crackers, cookies and wholesome snacks. Our “Right Bites” 100 calorie cookie and cracker packs performed well as we saw an increase in demand for portion controlled portable food. Our frozen and specialty channels business grew over 9%. Our food service business performed well, achieving mid single-digit growth for the year. Frozen realized strong sales driven by innovations such as Bake Shop Swirlz, Mini Muffin Tops and French Toast Waffles.

Our International operating segments collectively achieved net sales growth of 9%, or 5% on an internal basis. Europe’s internal net sales grew by almost 4% attributable to price/mix, as volume was down slightly. The UK and continental Europe have been impacted by the economic crisis which had consumers searching for value and retailers reducing inventory. Snacks products performed well across the

 

15


region, especially in the UK driven by Rice Krispies Squares. Latin America’s internal net sales growth was 4% attributable to our price increases and driven by cereal sales in Mexico and Venezuela. The growth in 2008 was on top of 2007 growth of 9%. Volume was down for 2008 due to the economic environment which impacted consumer confidence. Asia Pacific had a very strong year with 8% internal net sales growth. The growth was volume driven and broad based in both retail cereal and retail snacks.

Consolidated operating profit in 2008 grew by almost 5% on an as reported basis and 4% on an internal basis. Operating profit in all areas was impacted by cost pressures as discussed in more detail in the Margin performance section below. North America grew by 6% driven by growth in net sales and lower exit costs which offset higher commodity costs. Costs associated with the peanut-related recall of Kellogg products adversely impacted North America’s operating profit by $34 million or 2% of the full year operating profit. See the Voluntary product withdrawal section for more details. Operating profit declined slightly in both Europe and Latin America due to increased commodity costs and cost reduction initiatives. Asia Pacific’s operating profit increased 11% on an internal basis due to strong top line growth. On a consolidated basis, operating profit from acquisitions decreased internal operating profit by 1%, in line with our expectations, with Europe and Asia Pacific being particularly impacted by our Russian and Chinese acquisitions, respectively.

Margin performance

Margin performance was as follows:

 

                        Change vs.
prior year
(pts.)
 
   2009    2008    2007    2009      2008   

Gross margin (a)

   42.9%    41.9%    44.0%    1.0      (2.1

SGA% (b)

   –27.0%    –26.7%    –28.1%    (.3   1.4   

Operating margin

   15.9%    15.2%    15.9%    .7      (.7

 

(a) Gross profit as a percentage of net sales. Gross profit is equal to net sales less cost of goods sold.

 

(b) Selling, general and administrative expense as a percentage of net sales.

We strive for gross profit dollar growth to reinvest in brand-building and innovation expenditures. We maximize our gross profit dollars by managing external cost pressures through product pricing and mix improvements, implementing productivity savings and technological initiatives as well as entering into commodity hedges and fixed price contracts to reduce the cost of product ingredients and packaging. For full year 2009, our gross profit was up $24 million, despite the negative impact of foreign exchange of $213 million and $46 million of higher up-front costs in cost of goods sold (COGS).

 

As illustrated in the preceding table, our consolidated gross margin increased by 100 basis points in 2009. Our acquisitions lowered gross margin by approximately 10 basis points. Although moderating, we also continue to experience inflationary cost pressures for fuel, energy, commodities and employee benefits. During the year, higher costs, including increased investment in up-front costs recorded in COGS, were more than offset by savings from cost reduction initiatives and price increases. Our selling, general and administrative (SGA) expense as a percentage of net sales increased slightly due to higher up-front costs of $17 million recorded in overhead as well as an increase in advertising spend.

Our decline in gross margin for 2008 reflected the impact of significant cost pressure with higher costs for commodities, energy, and fuel being partially offset by the impact of cost reduction initiatives and increased pricing. For 2008, these cost pressures represented 10% of 2007’s COGS, primarily associated with our ingredient purchases. In 2008, acquisitions negatively impacted margin by 50 basis points. For 2008, our SGA% decreased over the prior year due to our strong net sales growth, lower expense related to cost reduction initiatives recorded in SGA expense, continued discipline in overhead spending and efficiencies in advertising and promotion.

Foreign currency translation

The reporting currency for our financial statements is the U.S. dollar. Certain of our assets, liabilities, expenses and revenues are denominated in currencies other than the U.S. dollar, primarily in the euro, British pound, Mexican peso, Australian dollar and Canadian dollar. To prepare our consolidated financial statements, we must translate those assets, liabilities, expenses and revenues into U.S. dollars at the applicable exchange rates. As a result, increases and decreases in the value of the U.S. dollar against these other currencies will affect the amount of these items in our consolidated financial statements, even if their value has not changed in their original currency. This could have significant impact on our results if such increase or decrease in the value of the U.S. dollar is substantial.

Due to potential volatility in the foreign exchange markets, we measure EPS growth and provide guidance on a currency neutral basis, assuming earnings are translated at the prior year’s exchange rates. This non-GAAP financial measure is being used to focus management and investors on local currency business results, thereby providing visibility to the underlying trends of the Company. Management believes that excluding the impact of foreign currency from EPS provides a better measurement of comparability given the volatility in foreign exchange markets.

 

16


Below is a reconciliation of reported EPS to currency neutral EPS for the fiscal years 2009, 2008 and 2007:

 

Consolidated results    2009    2008    2007  

Diluted net earnings per share (EPS)

   $ 3.16    $ 2.99    $ 2.76   

Translational impact (a)

     0.22           (0.07

Currency neutral EPS

   $ 3.38    $ 2.99    $ 2.69   

Currency neutral EPS growth (b)

     13%      8%      7%   

 

(a) Translation impact is the difference between reported EPS and the translation of current year net profits at prior year exchange rates, adjusted for gains (losses) on translational hedges.

 

(b) Calculated as a percentage of growth from the prior years’ reported EPS.

Exit or disposal activities

We view our continued spending on cost reduction initiatives as part of our ongoing operating principles to provide greater visibility in achieving our 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. Certain of these initiatives represent exit or disposal plans for which material charges will be incurred. We include these charges in our measure of operating segment profitability. Management announced its intention to achieve $1 billion of annual cost savings in three years (beginning in 2012). These initiatives are integral to meeting our $1 billion savings challenge.

Refer to Note 3 within Notes to Consolidated Financial Statements for further details on our exit or disposal activities.

Other cost reduction initiatives

2009 activities

We incurred costs related to our cost reduction initiatives which do not qualify as exit costs under generally accepted accounting principles in the United States. These represent cash costs for consulting and other charges for our COGS and SGA programs.

Costs incurred in fiscal year 2009 as well as total program costs are as follows (in millions):

 

(millions)  

For the year ended

January 2, 2010

 

Total program costs through

January 2, 2010

  COGS
programs
  SGA
Programs
  Total  

COGS

programs

 

SGA

Programs

  Total

North America

  $ 38   $ 13   $ 51   $ 50   $ 13   $ 63

Europe

    10     2     12     10     2     12

Latin America

    5         5     5         5

Asia Pacific

    5         5     5         5

Total

  $ 58   $ 15   $ 73   $ 70   $ 15   $ 85

The additional cost and cash outlay in 2010 for these programs, excluding exit costs, is estimated to be $30 to $35 million.

 

Prior year activities

During 2008, we incurred $17 million of expense related to the elimination of the accelerated ownership feature of certain employee stock options. Refer to Note 7 within Notes to Consolidated Financial Statements. This expense was recorded in SGA expense within corporate operating profit.

We also incurred $10 million of expense during 2008 in connection with a payment for the restructuring of our labor force at a manufacturing facility in Mexico. The cost, which was recorded in COGS and was attributable to the Latin America operating segment, resulted in employee benefit cost savings.

Interest expense

As illustrated in the following table, annual interest expense for the 2007-2009 periods has trended down slightly. The decline in 2009 was due primarily to lower commercial paper balances during the year, the impact of our fixed-to-variable interest rate swaps on our long-term debt and lower commercial paper interest rates, partially offset by the costs of early redemption of long-term debt, and interest on long-term debt issued in 2009. Interest income (recorded in other income (expense), net) was (in millions), 2009-$4; 2008-$20; 2007-$23. The decline for 2009 was primarily due to a drop in average interest rates. We currently expect that our 2010 gross interest expense will be approximately $250 to $260 million.

 

                          Change vs. prior  
year
(dollars in millions)    2009    2008    2007    2009    2008

Reported interest expense (a)

   $ 295    $ 308    $ 319      

Amounts capitalized

     3      6      5          

Gross interest expense

   $ 298    $ 314    $ 324    –5.1%    –3.1%

 

(a) Reported interest expense for 2009 and 2007 includes charges of approximately $35 and $5, respectively, related to the early redemption of long-term debt.

Other income (expense), net

Refer to Note 15 within to Notes to Consolidated Financial Statements.

Income taxes

Our long-term objective is to achieve a consolidated effective income tax rate of approximately 30% in comparison to a U.S. federal statutory income tax rate of 35%. We pursue planning initiatives globally in order to move toward our target. Excluding the impact of discrete adjustments and the cost of remitted and unremitted foreign earnings, our sustainable consolidated effective income tax rate for 2009 was 30%. For 2008 and 2007, it was 31% and 32% respectively. We currently expect our 2010 sustainable rate to be approximately 31%. Our reported rates of 28.2% for 2009, 29.7% for 2008 and 28.7% for 2007 were lower than the sustainable

 

17


rates for those years due to the favorable effect of various discrete adjustments such as audit settlements, international restructuring initiatives and statutory rate changes. Refer to Note 10 within Notes to Consolidated Financial Statements for further information. For 2010, we expect our consolidated effective income tax rate to be approximately 30% to 31%. This could be impacted if pending uncertain tax matters, including tax positions that could be affected by planning initiatives, are resolved more or less favorably than we currently expect. Fluctuations in foreign currency exchange rates could also impact the effective tax rate as it is dependent upon the U.S. dollar earnings of foreign subsidiaries doing business in various countries with differing statutory tax rates.

Voluntary product withdrawal

Refer to Note 13 within Notes to Consolidated Financial Statements.

 

Our principal source of liquidity is operating cash flows supplemented by borrowings for major acquisitions and other significant transactions. Our cash-generating capability is one of our fundamental strengths and provides us with substantial financial flexibility in meeting operating and investing needs.

We believe that our operating cash flows, together with our credit facilities and other available debt financing, will be adequate to meet our operating, investing and financing needs in the foreseeable future. However, there can be no assurance that volatility and/or disruption in the global capital and credit markets will not impair our ability to access these markets on terms acceptable to us, or at all.

Operating activities

The principal source of our operating cash flow is net earnings, meaning cash receipts from the sale of our products, net of costs to manufacture and market our products. Our cash conversion cycle (defined as days of inventory and trade receivables outstanding less days of trade payables outstanding, based on a trailing 12 month average) is relatively short, equating to approximately 23 days for 2009, 22 days for 2008, and 24 days for 2007. The increase in 2009 was the result of a decrease in days of trade payables outstanding, while the decrease in 2008 was the result of a decrease in days of inventory outstanding.

 

The following table presents the major components of our operating cash flow:

 

(dollars in millions)    2009     2008     2007  

Operating activities

      

Net income

   $ 1,208      $ 1,146      $ 1,102   

year-over-year change

     5.4%        4.0%     

Items in net income not requiring (providing) cash:

      

Depreciation and amortization

     384        375        372   

Deferred income taxes

     (40     157        (69

Other

     13        121        184   

Net income after non-cash items

     1,565        1,799        1,589   

year-over-year change

     –13.0%        13.2%     

Pension and other postretirement benefit plan contributions

     (100     (451     (96

Changes in operating assets and liabilities:

      

Core working capital (a)

     (147     121        16   

Other working capital

     325        (202     (6

Total

     178        (81     10   

Net cash provided by operating activities

   $ 1,643      $ 1,267      $ 1,503   

year-over-year change

     29.7%        –15.7%           

 

(a) Inventory, trade receivables and trade payables.

Our net cash provided by operating activities for 2009 was $376 million higher than in 2008, due primarily to positive cash flows associated with other working capital and lower pension and postretirement benefit plan contributions, partially offset by the impact of changes in core working capital and deferred income taxes in 2009.

Net cash provided by operating activities in 2008 was $236 million lower than 2007, due primarily to the increase in pension and other postretirement benefit plan contributions in 2008 and an unfavorable year-over-year variance in other working capital. Partially offsetting the decrease in 2008 operating cash flows was the impact of changes in deferred income taxes and a favorable variance in core working capital.

In 2009, core working capital was an average of 6.5% of net sales, an increase of 0.3% compared with 2008. In 2008, core working capital was an average of 6.2% of net sales, an improvement of 0.6% compared with 2007. We manage core working capital through timely collection of accounts receivable, extending terms on accounts payable and careful monitoring of inventory.

In 2009, the favorable year-over-year variance in other working capital was largely attributable to income taxes and advertising and promotion. Other working capital in 2008 reflected an increase in cash paid associated with hedging programs, cash paid for advertising and promotion, and the impact of changes in accrued salaries and wages.

Our total pension and postretirement plan funding amounted to $100 million, $451 million and $96 million, in 2009, 2008 and 2007, respectively. During 2008, adverse conditions in the equity markets caused

 

18


the actual rate of return on our pension and postretirement plan assets to be significantly below our assumed long-term rate of return of 8.9%. As a result, we decided to make additional contributions to our pension and postretirement plans amounting to $400 million in the fourth quarter of 2008.

The Pension Protection Act (PPA), and subsequent regulations, determines defined benefit plan minimum funding requirements in the United States. We believe that we will not be required to make any contributions under PPA requirements until 2013. Our projections concerning timing of PPA funding requirements are subject to change primarily based on general market conditions affecting trust asset performance, future discount rates based on average yields of high grade corporate bonds and our future decisions regarding certain elective provisions of the PPA.

We currently project that we will make total U.S. and foreign plan contributions in 2010 of approximately $50 million. Actual 2010 contributions could be different from our current projections, as influenced by our decision to undertake discretionary funding of our benefit trusts versus other competing investment priorities, future changes in government requirements, trust asset performance, renewals of union contracts, or higher-than-expected health care claims cost experience.

We measure cash flow as net cash provided by operating activities reduced by expenditures for property additions. We use this non-GAAP financial measure of cash flow to focus management and investors on the amount of cash available for debt repayment, dividend distributions, acquisition opportunities, and share repurchases. Our cash flow metric is reconciled to the most comparable GAAP measure, as follows:

 

(dollars in millions)    2009     2008     2007  

Net cash provided by operating activities

   $ 1,643      $ 1,267      $ 1,503   

Additions to properties

     (377     (461     (472

Cash flow

   $ 1,266      $ 806      $ 1,031   

year-over-year change

     57.1%        -21.8%           

Changes in cash flow (as defined) for 2009 and 2008 were primarily attributable to the additional $400 million in pension contributions we made in the fourth quarter of 2008 and lower capital expenditures 2009.

For 2010, we are expecting cash flow (as defined) to be comparable to 2009. We expect to achieve our target principally through operating profit growth, and continued prudent management of our working capital.

Investing activities

Our net cash used in investing activities for 2009 amounted to $370 million, a decrease of $311 million compared with 2008. Net cash used in investing activities of $681 million in 2008 increased by $80 million compared with 2007.

The reduction in cash used in investing activities in 2009 was attributable mainly to the reduction in business acquisition activity in 2009, and to a lesser extent, it also reflected lower capital spending. During 2008, we used cash to expand our platform for future growth with acquisitions in Russia, China, the U.S. and Australia. During 2007, we completed two business acquisitions in order to support the continued growth of our North America operating segment. Acquisitions are discussed in Note 2 within Notes to Consolidated Financial Statements.

Cash paid for additions to properties as a percentage of net sales amounted to 3.0% in 2009, 3.6% in 2008, and 4.0% in 2007.

In 2009, we spent capital for a new facility to manufacture ready-to-eat cereal in Mexico and completed the expansion of the global research center located in Battle Creek, Michigan, the W. K. Kellogg Institute for Food and Nutrition Research. The investment in our global research center, which began in 2008, reflects our commitment to innovation which is a key driver to the growth of our business. In 2008, we also incurred construction costs to increase manufacturing capacity in Europe. In 2007, we also increased capacity, including the purchase of a previously leased snacks manufacturing facility in Chicago, Illinois.

We continue to expect our Kellogg’s lean, efficient, and agile network (K LEAN) manufacturing efficiency initiative to result in a trend toward lower capital spending. Going forward, our long-term target for capital spending is between 3.0% and 4.0% of net sales. Our 2010 capital plan projects spending of $500 million, which is at the high end of our 3.0% to 4.0% range. This is driven by a significant investment in our information technology infrastructure as we reinstall and upgrade our SAP platform. We also have plans to expand our manufacturing capacity in 2010, primarily for Eggo® waffles in the U.S.

Financing activities

Our net cash used in financing activities for 2009, 2008 and 2007 amounted to $1,182 million, $780 million, and $788 million, respectively.

Total debt was $4.9 billion at year-end 2009 and $5.5 billion at year-end 2008. The reduction in total debt, primarily commercial paper, resulted from purchasing fewer shares of our stock in 2009 compared to 2008.

In November 2009, we issued $500 million of ten-year 4.15% fixed rate U.S. Dollar Notes, and used proceeds of $496 million to retire a portion of our 6.6% U.S. Dollar Notes due 2011. We retired $482 million

 

19


of the 2011 debt through a tender offer, which resulted in $35 million of interest expense and an acceleration of $3 million loss on an interest rate swap, which was previously recorded in accumulated other comprehensive income. These charges were included in cash flows from operating activities. This debt had an effective interest rate of 7.08%. In May 2009, we issued $750 million of seven-year 4.45% fixed rate U.S. Dollar Notes, and used proceeds of $745 million to pay down commercial paper. In May 2009, we also entered into interest rate swaps on $1,150 million of our debt. Interest rate swaps with notional amounts totaling $750 million effectively converted our 5.125% U.S. Dollar Notes due 2012 from a fixed rate to a floating rate obligation for the remainder of the five-year term. In addition, interest rate swaps with notional amounts totaling $400 million effectively converted a portion of our 6.6% U.S. Dollar Notes due 2011 from a fixed rate to a floating rate obligation for the remaining term.

In March 2008, we issued $750 million of five-year 4.25% fixed rate U.S. Dollar Notes under an existing shelf registration statement. We used proceeds of $746 million from issuance of this long-term debt to retire a portion of our commercial paper. In conjunction with this debt issuance, we entered into interest rate swaps with notional amounts totaling $750 million, which effectively converted this debt from a fixed rate to a floating rate obligation for the duration of the five-year term. In 2008, we had cash outflows of $465 million in connection with the repayment of five-year U.S. Dollar Notes at maturity in June 2008. That debt had an effective interest rate of 3.35%.

In February 2007, we redeemed Euro Notes for $728 million. To partially finance this redemption, we established a program to issue euro commercial paper notes up to a maximum aggregate amount outstanding at any time of $750 million or its equivalent in alternative currencies. In December 2007, the Company issued $750 million of five-year 5.125% fixed rate U.S. Dollar Notes under the existing shelf registration statement, using the proceeds to replace a portion of our U.S. commercial paper.

Our Board of Directors authorized stock repurchases of up to $650 million for 2009. During 2009, we spent $187 million to purchase approximately 4 million shares of common stock. The unused portion of the 2009 authorization, amounting to $463 million, was rolled over and is available to be executed against in 2010. The Board of Directors has authorized an additional stock repurchase program of up to $650 million bringing the total 2010 stock repurchase authorization to $1,113 million. During 2008 and 2007, we repurchased $650 million of our common stock each year under programs authorized by our Board of Directors. The number of shares repurchased amounted to approximately 13 million and 12 million shares, respectively, in 2008 and 2007. A separate $500 million share repurchase authorization received Board approval in third quarter 2008. We made no share repurchases under this authorization because we decided to use cash to fund pension plans and reduce commercial paper in the fourth quarter of 2008. The $500 million share repurchase authorization was later canceled.

We paid quarterly dividends to shareholders totaling $1.43 per share in 2009, $1.30 per share in 2008 and $1.202 per share in 2007. Total cash paid for dividends increased by 10.3% in 2009 and 4.2% in 2008. Our objective is to maintain our dividend pay-out ratio between 40% and 50% of reported net earnings.

Our long-term debt agreements contain customary covenants that limit the Company and some of its subsidiaries from incurring certain liens or from entering into certain sale and lease-back transactions. Some agreements also contain change in control provisions. However, they do not contain acceleration of maturity clauses that are dependent on credit ratings. A change in the Company’s credit ratings could limit our access to the U.S. short-term debt market and/or increase the cost of refinancing long-term debt in the future. However, even under these circumstances, we would continue to have access to our Five-Year Credit Agreement, which expires in 2011, under which we can borrow up to $2.0 billion on a revolving credit basis. This source of liquidity is unused and available on an unsecured basis, although we do not currently plan to use it.

During the third quarter of 2008 and thereafter, capital and credit markets, including commercial paper markets, experienced increased instability and disruption as the U.S. and global economies underwent a period of extreme uncertainty. Throughout this period of uncertainty, we continued to have access to the U.S. and Canadian commercial paper markets. Our commercial paper and term debt credit ratings have not been affected by the changes in the credit environment, and the amount of our total debt outstanding remained relatively flat over the past three years.

We monitor the financial strength of our third-party financial institutions, including those that hold our cash and cash equivalents as well as those who serve as counterparties to our credit facilities, our derivative financial instruments, and other arrangements.

We continue to believe that we will be able to meet our interest and principal repayment obligations and maintain our debt covenants for the foreseeable future, while still meeting our operational needs, including the pursuit of selected bolt-on acquisitions. This will be accomplished through our strong cash flow, our short-term borrowings, and our maintenance of credit facilities on a global basis.

 

20


OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

Off-balance sheet arrangements

As of January 2, 2010 and January 3, 2009 the Company did not have any material off-balance sheet arrangements.

Contractual obligations

The following table summarizes future estimated cash payments to be made under existing contractual obligations. Further information on debt obligations is contained in Note 6 within Notes to Consolidated Financial Statements. Further information on lease obligations is contained in Note 5. Further information on uncertain tax positions is contained in Note 10.

 

Contractual obligations    Payments due by period
(millions)    Total    2010    2011    2012    2013    2014    2015 and
beyond

Long-term debt:

                    

Principal

   $ 4,809    $ 1    $ 946    $ 751    $ 752    $ 8    $ 2,351

Interest (a)

     2,450      234      219      211      144      136      1,506

Capital leases

     6      2      1      1      1           1

Operating leases

     604      141      122      91      66      51      133

Purchase obligations (b)

     628      534      50      22      7      6      9

Uncertain tax positions (c)

     35      35                         

Other long-term (d)

     1,002      105      93      60      95      254      395

Total

   $ 9,534    $ 1,052    $ 1,431    $ 1,136    $ 1,065    $ 455    $ 4,395

 

(a) Includes interest payments on long-term fixed rate debt.

 

(b) Purchase obligations consist primarily of fixed commitments under various co-marketing agreements and to a lesser extent, of service agreements, and contracts for future delivery of commodities, packaging materials, and equipment. The amounts presented in the table do not include items already recorded in accounts payable or other current liabilities at year-end 2009, nor does the table reflect cash flows we are likely to incur based on our plans, but are not obligated to incur. Therefore, it should be noted that the exclusion of these items from the table could be a limitation in assessing our total future cash flows under contracts.

 

(c) In addition to the $35 million reported in the 2010 column and classified as a current liability, the Company has $98 million recorded in long-term liabilities for which it is not reasonably possible to predict when it may be paid.

 

(d) Other long-term contractual obligations are those associated with noncurrent liabilities recorded within the Consolidated Balance Sheet at year-end 2009 and consist principally of projected commitments under deferred compensation arrangements, multiemployer plans, and supplemental employee retirement benefits. The table also includes our current estimate of minimum contributions to defined benefit pension and postretirement benefit plans through 2015 as follows: 2010-$47; 2011-$53; 2012-$36; 2013-$77; 2014-$240; 2015-$226.

 

CRITICAL ACCOUNTING ESTIMATES

Promotional expenditures

Our promotional activities are conducted either through the retail trade or directly with consumers and include activities such as in-store displays and events, feature price discounts, consumer coupons, contests and loyalty programs. The costs of these activities are generally recognized at the time the related revenue is recorded, which normally precedes the actual cash expenditure. The recognition of these costs therefore requires management judgment regarding the volume of promotional offers that will be redeemed by either the retail trade or consumer. These estimates are made using various techniques including historical data on performance of similar promotional programs. Differences between estimated expense and actual redemptions are normally insignificant and recognized as a change in management estimate in a subsequent period. On a full-year basis, these subsequent period adjustments have rarely represented more than 0.3% of our Company’s net sales. However, our Company’s total promotional expenditures (including amounts classified as a revenue reduction) represented approximately 40% of 2009 net sales; therefore, it is likely that our results would be materially different if different assumptions or conditions were to prevail.

Goodwill and other intangible assets

We perform an impairment evaluation of goodwill and intangible assets with indefinite useful lives at least annually during the fourth quarter of each year in conjunction with our annual budgeting process. Goodwill impairment testing first requires a comparison between the carrying value and fair value of a reporting unit with associated goodwill. Carrying value is based on the assets and liabilities associated with the operations of that reporting unit, which often requires allocation of shared or corporate items among reporting units. For the 2009 goodwill impairment test, the fair value of the reporting units was estimated based on market multiples. Our

 

21


approach employs market multiples based on earnings before interest, taxes, depreciation and amortization and earnings for companies comparable to our reporting units. Management believes the assumptions used for the impairment test are consistent with those utilized by a market participant performing similar valuations for our reporting units.

Similarly, impairment testing of other intangible assets requires a comparison of carrying value to fair value of that particular asset. Fair values of non-goodwill intangible assets are based primarily on projections of future cash flows to be generated from that asset. For instance, cash flows related to a particular trademark would be based on a projected royalty stream attributable to branded product sales discounted at rates consistent with rates used by market participants. These estimates are made using various inputs including historical data, current and anticipated market conditions, management plans, and market comparables.

We also evaluate the useful life over which a non-goodwill intangible asset is expected to contribute directly or indirectly to the cash flows of the Company. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized, but is evaluated annually for impairment. Reaching a determination on useful life requires significant judgments and assumptions regarding the future effects of obsolescence, demand, competition, other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels), the level of required maintenance expenditures, and the expected lives of other related groups of assets.

At January 2, 2010, goodwill and other intangible assets amounted to $5.1 billion, consisting primarily of goodwill and trademarks associated with the 2001 acquisition of Keebler Foods Company. Within this total, approximately $1.4 billion of non-goodwill intangible assets were classified as indefinite-lived, comprised principally of Keebler trademarks. We currently believe that the fair value of our goodwill and other intangible assets exceeds their carrying value and that those intangibles so classified will contribute indefinitely to the cash flows of the Company. At January 2, 2010, the fair value of our North America snacks reporting unit was almost twice its book value. However, if we had used materially different assumptions, which we do not believe are reasonably possible, regarding the future performance of our business or a different weighted-average cost of capital in the valuation, this could have resulted in significant impairment losses and/or amortization expense.

 

Retirement benefits

Our Company sponsors a number of U.S. and foreign defined benefit employee pension plans and also provides retiree health care and other welfare benefits in the United States and Canada. Plan funding strategies are influenced by tax regulations and asset return performance. A substantial majority of plan assets are invested in a globally diversified portfolio of equity securities with smaller holdings of debt securities and other investments. We recognize the cost of benefits provided during retirement over the employees’ active working life to determine the obligations and expense related to our retiree benefit plans. Inherent in this concept is the requirement to use various actuarial assumptions to predict and measure costs and obligations many years prior to the settlement date. Major actuarial assumptions that require significant management judgment and have a material impact on the measurement of our consolidated benefits expense and accumulated obligation include the long-term rates of return on plan assets, the health care cost trend rates, and the interest rates used to discount the obligations for our major plans, which cover employees in the United States, United Kingdom and Canada.

To conduct our annual review of the long-term rate of return on plan assets, we model expected returns over a 20-year investment horizon with respect to the specific investment mix of each of our major plans. The return assumptions used reflect a combination of rigorous historical performance analysis and forward-looking views of the financial markets including consideration of current yields on long-term bonds, price-earnings ratios of the major stock market indices, and long-term inflation. Our U.S. plan model, corresponding to approximately 68% of our trust assets globally, currently incorporates a long-term inflation assumption of 2.5% and an active management premium of 1% (net of fees) validated by historical analysis. Although we review our expected long-term rates of return annually, our benefit trust investment performance for one particular year does not, by itself, significantly influence our evaluation. Our expected rates of return are generally not revised, provided these rates continue to fall within a “more likely than not” corridor of between the 25th and 75th percentile of expected long-term returns, as determined by our modeling process. Our assumed rate of return for U.S. plans in 2009 of 8.9% equated to approximately the 58th percentile expectation of our 2009 model. Similar methods are used for various foreign plans with invested assets, reflecting local economic conditions. Foreign trust investments represent approximately 32% of our global benefit plan assets.

Based on consolidated benefit plan assets at January 2, 2010, a 100 basis point reduction in the assumed rate of return would increase 2010 benefits expense by approximately $40 million.

 

22


Correspondingly, a 100 basis point shortfall between the assumed and actual rate of return on plan assets for 2010 would result in a similar amount of arising experience loss. Any arising asset-related experience gain or loss is recognized in the calculated value of plan assets over a five-year period. Once recognized, experience gains and losses are amortized using a declining-balance method over the average remaining service period of active plan participants, which for U.S. plans is presently about 12 years. Under this recognition method, a 100 basis point shortfall in actual versus assumed performance of all of our plan assets in 2010 would reduce pre-tax earnings by approximately $1.4 million in 2011, increasing to approximately $7 million in 2015. For each of the three fiscal years, our actual return on plan assets exceeded (was less than) the recognized assumed return by the following amounts (in millions): 2009-$507; 2008–$(1,528); 2007–$(99).

To conduct our annual review of health care cost trend rates, we model our actual claims cost data over a five-year historical period, including an analysis of pre-65 versus post-65 age groups and other important demographic components in our covered retiree population. This data is adjusted to eliminate the impact of plan changes and other factors that would tend to distort the underlying cost inflation trends. Our initial health care cost trend rate is reviewed annually and adjusted as necessary to remain consistent with recent historical experience and our expectations regarding short-term future trends. In comparison to our actual five-year compound annual claims cost growth rate of approximately 2.4%, our initial trend rate for 2010 of 7.1% reflects the expected future impact of faster-growing claims experience for certain demographic groups within our total employee population. Our initial rate is trended downward by 0.5% per year, until the ultimate trend rate of 4.5% is reached. The ultimate trend rate is adjusted annually, as necessary, to approximate the current economic view on the rate of long-term inflation plus an appropriate health care cost premium. Based on consolidated obligations at January 2, 2010, a 100 basis point increase in the assumed health care cost trend rates would increase 2010 benefits expense by approximately $17 million. A 100 basis point excess of 2010 actual health care claims cost over that calculated from the assumed trend rate would result in an arising experience loss of approximately $9 million. Any arising health care claims cost-related experience gain or loss is recognized in the calculated amount of claims experience over a four-year period. Once recognized, experience gains and losses are amortized using a straight-line method over 15 years. The net experience gain arising from recognition of 2009 claims experience was approximately $16 million.

To conduct our annual review of discount rates, we selected the discount rate using the spot yield curve underlying the Citigroup Index (published monthly by Citigroup). Using this methodology, we determined the single discount rate for each of our retirement plans that was equivalent to discounting against the entire Citigroup spot yield curve. The measurement dates for our defined benefit plans are consistent with our fiscal year end. Accordingly, we select discount rates to measure our benefit obligations that are consistent with market indices during December of each year.

Based on consolidated obligations at January 2, 2010, a 25 basis point decline in the weighted-average discount rate used for benefit plan measurement purposes would increase 2010 benefits expense by approximately $14 million. All obligation-related experience gains and losses are amortized using a straight-line method over the average remaining service period of active plan participants.

Despite the previously-described rigorous policies for selecting major actuarial assumptions, we periodically experience material differences between assumed and actual experience. As of January 2, 2010, we had consolidated unamortized prior service cost and net experience losses of approximately $1.7 billion, as compared to approximately $1.9 billion at January 3, 2009. The year-over-year decrease in net unamortized amounts was attributable primarily to favorable asset performance during 2009. Of the total unamortized amounts at January 2, 2010, approximately $1.5 billion was related to asset losses that occurred during 2008, offset by $0.5 billion in asset gains during 2009, with the remainder largely related to discount rate reductions and net unfavorable health care claims experience (including upward revisions in the assumed trend rate) prior to 2009. For 2010, we currently expect total amortization of prior service cost and net experience losses to be approximately $37 million higher than the actual 2009 amount of approximately $73 million. Total employee benefit expense for 2010 is expected to be higher than 2009 due to lower discount rates, a further phase in of the 2008 investment losses, offset by better than expected 2009 investment performance. Based on our current actuarial assumptions, we expect 2011 pension expense to increase significantly primarily due to the amortization of net experience losses.

During 2009 we made contributions in the amount of $87 million to Kellogg’s global tax-qualified pension programs. This amount was mostly discretionary. We anticipate making additional contributions in future years due to the poor performance of global equity markets during 2008. Additionally we contributed $13 million to our retiree medical programs; most of this contribution was also discretionary and largely used to fund benefit obligations related to our union retiree healthcare benefits.

Assuming actual future experience is consistent with our current assumptions, annual amortization of accumulated prior service cost and net experience

 

23


losses during each of the next several years would increase versus the 2009 amount.

Income taxes

Our consolidated effective income tax rate is influenced by tax planning opportunities available to us in the various jurisdictions in which we operate. Judgment is required in evaluating our tax positions to determine how much benefit should be recognized in our income tax expense. We establish tax reserves associated with uncertain tax positions based on a benefit recognition model, which we believe could result in a greater amount of benefit (and a lower amount of reserve) being initially recognized in certain circumstances.

The Company evaluates uncertain tax positions in two steps. The first step is to determine whether it is more-likely-than not that a tax position will be sustained upon examination based upon the technical merit of the position. In weighing the technical merits of the position, we consider the facts and circumstances of the position; we assume the reviewing tax authority has full knowledge of the position; and we consider the weight of authoritative guidance. The second step is measurement; a tax position that meets the more-likely-than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. While reviewing the ranges of probable outcomes, the Company records the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The tax position will be derecognized when it is no longer more-likely-than not of being sustained.

For the periods presented, our income tax and related interest reserves have averaged approximately $130 million. Reserve adjustments for individual issues have rarely exceeded 1% of earnings before income taxes annually. Significant tax reserve adjustments impacting our effective tax rate would be separately presented in the rate reconciliation table of Note 10 within Notes to Consolidated Financial Statements.

The current portion of our tax reserves and related interest reserves are presented in the Consolidated Balance Sheet within other current liabilities and the amount expected to be settled after one year is recorded in other liabilities.

 

ACCOUNTING STANDARDS TO BE ADOPTED IN FUTURE PERIODS

Variable Interest Entities

In June 2009, the Financial Accounting Standards Board (FASB) issued guidance that changed the consolidation model for variable interest entities (VIEs). This guidance requires companies to qualitatively assess the determination of the primary beneficiary of a VIE based on whether a company (1) has the power to direct matters that most significantly impact the activities of the VIE, and (2) has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. This standard is effective at the beginning of our 2010 fiscal year and must be applied retrospectively. The adoption of this guidance will not have a significant impact on our financial statements.

 

Despite a tough economy in 2009, we met or exceeded all of our long-term annual targets. We are poised to continue this momentum in 2010. We expect our business model and strategy will deliver internal net sales growth of 2 to 3%, in line with our long-term annual targets of low single-digits (1 to 3%). Internal operating profit is expected to grow 8 to 10%, above our long-term annual target of mid single-digits (4 to 6%). We expect this growth to result from savings from our up-front cost programs as well as lower spending on up-front costs. We expect our earnings per share to grow 11 to 13%, above our long-term annual target of high single-digit (7 to 9%) growth on a currency neutral basis. Gross profit margin percentage is expected to expand by approximately 100 basis points as our savings from cost reduction initiatives will more than offset pressure on cost of goods sold. Gross interest expense for 2010 is expected to decline to approximately $250 to $260 million. Our effective tax rate is estimated to be approximately 30% to 31%. We continue to remain committed to investing in brand building, cost-reduction initiatives, and other growth opportunities. Lastly, we expect our cash flow performance to remain strong and are currently expecting 2010 cash flow to be similar to 2009’s result of $1,266 million after capital expenditures.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our Company is exposed to certain market risks, which exist as a part of our ongoing business operations. We use derivative financial and commodity instruments, where appropriate, to manage these risks. As a matter of policy, we do not engage in trading or speculative transactions. Refer to Note 12 within Notes to Consolidated Financial Statements for further information on our derivative financial and commodity instruments.

Foreign exchange risk

Our Company is exposed to fluctuations in foreign currency cash flows related to third-party purchases, intercompany loans and product shipments. Our Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, our Company is exposed to

 

24


volatility in the translation of foreign currency earnings to U.S. dollars. Primary exposures include the U.S. dollar versus the British pound, euro, Australian dollar, Canadian dollar, and Mexican peso, and in the case of inter-subsidiary transactions, the British pound versus the euro. We assess foreign currency risk based on transactional cash flows and translational volatility and may enter into forward contracts, options, and currency swaps to reduce fluctuations in net long or short currency positions. Forward contracts and options are generally less than 18 months duration. Currency swap agreements are established in conjunction with the term of underlying debt issuances.

The total notional amount of foreign currency derivative instruments at year-end 2009 was $1,588 million, representing a settlement obligation of $24 million. The total notional amount of foreign currency derivative instruments at year-end 2008 was $924 million, representing a settlement receivable of $22 million. All of these derivatives were hedges of anticipated transactions, translational exposure, or existing assets or liabilities, and mature within 18 months. Assuming an unfavorable 10% change in year-end exchange rates, the settlement obligation would have increased by approximately $159 million at year-end 2009 and the settlement receivable would have decreased by $92 million at year-end 2008. These unfavorable changes would generally have been offset by favorable changes in the values of the underlying exposures.

With regard to our foreign currency exchange risk, we continue to monitor the highly volatile economic environment in Venezuela. On January 8, 2010, the Venezuelan government instituted a two tier official exchange rate system which was effective as of January 11, 2010. This resulted in a devaluation of the official rate that had previously been at 2.15 bolivars per $1. A preferential rate for essential items such as medical, food and heavy machinery was established at 2.6 bolivars per $1, referred to as the “preferential rate”. All other imports will be imported at 4.3 bolivars per $1, referred to as the “oil rate”. The government is compiling a list of the items it deems essential which can be imported at the preferential rate. We are in the process of determining which exchange rates will be applicable to our imports into Venezuela. However, currency exchange restrictions in Venezuela restrict our ability to obtain U.S. dollars at the official exchange rates. U.S. dollars may be obtained through a legal parallel exchange mechanism. We have and may continue to use this mechanism to exchange bolivars for U.S. dollars in order to satisfy U.S. dollar denominated obligations of our Venezuelan operations. As such, as of the end of our 2009 fiscal year, we are using the parallel rate to translate our Venezuelan subsidiary’s financial statements to U.S. dollars. The impact of this change was not material to the Consolidated Financial Statements despite rates implied by transactions in the parallel market being significantly higher than the official rates.

Inflation in Venezuela has been at relatively high levels over the past few years. We use a blend of the National Consumer Price Index and the Consumer Price Index to determine whether Venezuela is a highly inflationary economy. The blended index exceeded 100% during the fourth quarter of 2009 and as such, Venezuela will be designated as a highly inflationary economy as of the beginning of our 2010 fiscal year. Gains and losses resulting from the translation of the financial statements of subsidiaries operating in highly inflationary economies are recorded in earnings. We expect reported net sales and operating profit in Latin America will be negatively impacted, and it could be significant to our Latin America operating segment. On a consolidated basis, Venezuela represents only 1% to 2% of our business; therefore, the overall impact is expected to be minimal.

Interest rate risk

Our Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing and future issuances of variable rate debt. Primary exposures include movements in U.S. Treasury rates, London Interbank Offered Rates (LIBOR), and commercial paper rates. We periodically use interest rate swaps and forward interest rate contracts to reduce interest rate volatility and funding costs associated with certain debt issues, and to achieve a desired proportion of variable versus fixed rate debt, based on current and projected market conditions.

During 2009 and 2008, we entered into interest rate swaps in connection with certain U.S. Dollar Notes. Refer to disclosures contained in Note 6 within Notes to Consolidated Financial Statements. The total notional amount of our interest rate swaps was $1,900 million and $750 million, as of January 2, 2010 and January 3, 2009, respectively. Assuming average variable rate debt levels during the year, a one percentage point increase in interest rates would have increased interest expense by approximately $22 million in 2009 and $21 million in 2008.

Price risk

Our Company is exposed to price fluctuations primarily as a result of anticipated purchases of raw and packaging materials, fuel, and energy. Primary exposures include corn, wheat, soybean oil, sugar, cocoa, paperboard, natural gas, and diesel fuel. We have historically used the combination of long-term contracts with suppliers, and exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted raw material purchases over a duration of generally less than 18 months. During 2006, we entered into two separate 10-year over-the-counter commodity swap

 

25


transactions to reduce fluctuations in the price of natural gas used principally in our manufacturing processes. The notional amount of the swaps totaled $146 million as of January 2, 2010 and equates to approximately 50% of our North America manufacturing needs over the remaining hedge period. At year-end 2008 the notional amount was $167 million.

The total notional amount of commodity derivative instruments at year-end 2009, including the North America natural gas swaps, was $213 million, representing a settlement obligation of approximately $16 million. Assuming a 10% decrease in year-end commodity prices, the settlement obligation would increase by approximately $18 million, generally offset by a reduction in the cost of the underlying commodity purchases. The total notional amount of commodity derivative instruments at year-end 2008, including the natural gas swaps, was $267 million, representing a settlement obligation of approximately $16 million. Assuming a 10% decrease in year-end commodity prices, this settlement obligation would increase by approximately $24 million, generally offset by a reduction in the cost of the underlying commodity purchases.

In some instances the Company has reciprocal collateralization agreements with counterparties regarding fair value positions in excess of certain thresholds. These agreements 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 our counterparties exceeds a certain amount. There were no collateral balance requirements at January 2, 2010 or January 3, 2009.

In addition to the commodity derivative instruments discussed above, we use long-term contracts with suppliers to manage a portion of the price exposure associated with future purchases of certain raw materials, including rice, sugar, cartonboard, and corrugated boxes. It should be noted the exclusion of these contracts from the analysis above could be a limitation in assessing the net market risk of our Company.

 

26


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Kellogg Company and Subsidiaries

Consolidated Statement of Income

 

(millions, except per share data)    2009        2008        2007  

Net sales

   $ 12,575         $ 12,822         $ 11,776   

Cost of goods sold

     7,184           7,455           6,597   

Selling, general and administrative expense

     3,390           3,414           3,311   

Operating profit

   $ 2,001         $ 1,953         $ 1,868   

Interest expense

     295           308           319   

Other income (expense), net

     (22        (14        (3

Income before income taxes

     1,684           1,631           1,546   

Income taxes

     476           485           444   

Net income

   $ 1,208         $ 1,146         $ 1,102   

Net loss attributable to noncontrolling interests

     (4        (2        (1

Net income attributable to Kellogg Company

   $ 1,212         $ 1,148         $ 1,103   

Per share amounts:

            

Basic

   $ 3.17         $ 3.01         $ 2.79   

Diluted

   $ 3.16         $ 2.99         $ 2.76   

Dividends per share

   $ 1.430         $ 1.300         $ 1.202   

Refer to Notes to Consolidated Financial Statements.

 

27

 


Kellogg Company and Subsidiaries

Consolidated Balance Sheet

 

(millions, except share data)    2009        2008  

Current assets

       

Cash and cash equivalents

   $ 334         $ 255   

Accounts receivable, net

     1,093           1,100   

Inventories

     910           897   

Other current assets

     221           269   

Total current assets

   $ 2,558         $ 2,521   

Property, net

     3,010           2,933   

Goodwill

     3,643           3,637   

Other intangibles, net

     1,458           1,461   

Other assets

     531           394   

Total assets

   $ 11,200         $ 10,946   

Current liabilities

       

Current maturities of long-term debt

   $ 1         $ 1   

Notes payable

     44           1,387   

Accounts payable

     1,077           1,135   

Other current liabilities

     1,166           1,029   

Total current liabilities

   $ 2,288         $ 3,552   

Long-term debt

     4,835           4,068   

Deferred income taxes

     425           300   

Pension liability

     430           631   

Other liabilities

     947           940   

Commitments and contingencies

       

Equity

       

Common stock, $.25 par value, 1,000,000,000 shares authorized
Issued: 419,058,168 shares in 2009 and 418,842,707 shares in 2008

     105           105   

Capital in excess of par value

     472           438   

Retained earnings

     5,481           4,836   

Treasury stock at cost
37,678,215 shares in 2009 and 36,981,580 shares in 2008

     (1,820        (1,790

Accumulated other comprehensive income (loss)

     (1,966        (2,141

Total Kellogg Company equity

     2,272           1,448   

Noncontrolling interests

     3           7   

Total equity

     2,275           1,455   

Total liabilities and equity

   $ 11,200         $ 10,946   

Refer to Notes to Consolidated Financial Statements.

 

28

 


29

 

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
(a)

    Total
equity
    Total
comprehensive
income (loss)
 
                     
  shares   amount       shares     amount            

Balance, December 30, 2006

  419   $ 105   $ 292      $ 3,630      21      $ (912   $ (1,046   $ 2,069      $ 3      $ 2,072      $ 1,126   
                           

Impact of adoption of accounting standard for uncertain tax positions

          2              2          2     

Common stock repurchases

          12        (650       (650       (650  

Net income (loss)

          1,103              1,103        (1     1,102        1,102   

Dividends

          (475           (475       (475  

Other comprehensive income (loss)

                219        219          219        219   

Stock compensation

        69                69          69     

Stock options exercised and other

              27        (43   (4     205                189                189           

Balance, December 29, 2007

  419   $ 105   $ 388      $ 4,217      29      $ (1,357   $ (827   $ 2,526      $ 2      $ 2,528      $ 1,321   
                           

Common stock repurchases

          13        (650       (650       (650  

Business acquisitions

                    7        7     

Net income (loss)

          1,148              1,148        (2     1,146        1,146   

Dividends

          (495           (495       (495  

Other comprehensive income (loss)

                (1,314     (1,314       (1,314     (1,314

Stock compensation

        51                51          51     

Stock options exercised and other

              (1     (34   (5     217                182                182           

Balance, January 3, 2009

  419   $ 105   $ 438      $ 4,836      37      $ (1,790   $ (2,141   $ 1,448      $ 7      $ 1,455      $ (168
                           

Common stock repurchases

          4        (187       (187       (187  

Net income (loss)

          1,212              1,212        (4     1,208        1,208   

Dividends

          (546           (546       (546  

Other comprehensive income (loss)

                175        175          175        175   

Stock compensation

        37                37          37     

Stock options exercised and other

              (3     (21   (3     157                133                133           

Balance, January 2, 2010

  419   $ 105   $ 472      $ 5,481      38      $ (1,820   $ (1,966   $ 2,272      $ 3      $ 2,275      $ 1,383   

 

(a) Refer to Note 1 for further information.

Refer to Notes to Consolidated Financial Statements.

 


Kellogg Company and Subsidiaries

Consolidated Statement of Cash Flows

 

(millions)    2009        2008        2007  

Operating activities

            

Net income

   $ 1,208         $ 1,146         $ 1,102   

Adjustments to reconcile net income to operating cash flows:

            

Depreciation and amortization

     384           375           372   

Deferred income taxes

     (40        157           (69

Other

     13           121           184   

Pension and other postretirement benefit contributions

     (100        (451        (96

Changes in operating assets and liabilities:

            

Trade receivables

     (75        48           (63

Inventories

     (13        41           (88

Accounts payable

     (59        32           167   

Accrued income taxes

     112           (85        (67

Accrued interest expense

     (5        3           (1

Accrued and prepaid advertising, promotion and trade allowances

     91           (10        36   

Accrued salaries and wages

     21           (45        5   

Exit plan-related reserves

     21           (2        (9

All other current assets and liabilities

     85           (63        30   

Net cash provided by operating activities

   $ 1,643         $ 1,267         $ 1,503   

Investing activities

            

Additions to properties

   $ (377      $ (461      $ (472

Acquisitions of businesses, net of cash acquired

               (213        (128

Other

     7           (7        (1

Net cash used in investing activities

   $ (370 )       $ (681      $ (601

Financing activities

            

Net increase (reduction) of notes payable, with maturities less than or equal to 90 days

   $ (1,284      $ 23         $ 625   

Issuances of notes payable, with maturities greater than 90 days

     10           190           804   

Reductions of notes payable, with maturities greater than 90 days

     (70        (316        (1,209

Issuances of long-term debt

     1,241           756           750   

Reductions of long-term debt

     (482        (468        (802

Net issuances of common stock

     131           175           163   

Common stock repurchases

     (187        (650        (650

Cash dividends

     (546        (495        (475

Other

     5           5           6   

Net cash used in financing activities

   $ (1,182 )       $ (780      $ (788

Effect of exchange rate changes on cash and cash equivalents

     (12 )         (75        (1

Increase (decrease) in cash and cash equivalents

   $ 79         $ (269      $ 113   

Cash and cash equivalents at beginning of year

     255           524           411   

Cash and cash equivalents at end of year

   $ 334         $ 255         $ 524   

Refer to Notes to Consolidated Financial Statements.

 

30

 


Kellogg Company and Subsidiaries

Notes to Consolidated Financial Statements

 

NOTE 1

ACCOUNTING POLICIES

Basis of presentation

The consolidated financial statements include the accounts of Kellogg Company and its majority-owned subsidiaries (Kellogg or the Company). Intercompany balances and transactions are eliminated.

The Company’s fiscal year normally ends on the Saturday closest to December 31 and as a result, a 53rd week is added approximately every sixth year. The Company’s 2009 and 2007 fiscal years each contained 52 weeks and ended on January 2, 2010 and December 29, 2007, respectively. The Company’s 2008 fiscal year ended on January 3, 2009, and included a 53rd week. While quarters normally consist of 13-week periods, the fourth quarter of fiscal 2008 included a 14th week.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates.

Cash and cash equivalents

Highly liquid investments with original maturities of three months or less are considered to be cash equivalents.

Accounts receivable

Accounts receivable consists principally of trade receivables, which are recorded at the invoiced amount, net of allowances for doubtful accounts and prompt payment discounts. Trade receivables do not bear interest. The allowance for doubtful accounts represents management’s estimate of the amount of probable credit losses in existing accounts receivable, as determined from a review of past due balances and other specific account data. Account balances are written off against the allowance when management determines the receivable is uncollectible. The Company does not have off-balance sheet credit exposure related to its customers.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined on an average cost basis.

 

Property

The Company’s property consists mainly of plants and equipment used for manufacturing activities. These assets are recorded at cost and depreciated over estimated useful lives using straight-line methods for financial reporting and accelerated methods, where permitted, for tax reporting. Major property categories are depreciated over various periods as follows (in years): manufacturing machinery and equipment 5-20; computer and other office equipment 3-5; building components 15-30; building structures 50. Cost includes interest associated with significant capital projects. Plant and equipment are reviewed for impairment when conditions indicate that the carrying value may not be recoverable. Such conditions include an extended period of idleness or a plan of disposal. Assets to be disposed of at a future date are depreciated over the remaining period of use. Assets to be sold are written down to realizable value at the time the assets are being actively marketed for sale and a sale is expected to occur within one year. As of year-end 2009 and 2008, the carrying value of assets held for sale was insignificant.

Goodwill and other intangible assets

The Company’s goodwill and intangible assets are comprised primarily of amounts related to the 2001 acquisition of Keebler Foods Company (Keebler). Management expects the Keebler trademarks to contribute indefinitely to the cash flows of the Company. Accordingly, these intangible assets have been classified as having indefinite lives. Goodwill and indefinite-lived intangibles are not amortized, but are tested at least annually for impairment. An intangible asset with a finite life is amortized on a straight-line basis over the estimated useful life.

For the goodwill impairment test, the fair value of the reporting units are estimated based on market multiples. This approach employs market multiples based on earnings before interest, taxes, depreciation and amortization and earnings for companies that are comparable to the Company’s reporting units. The assumptions used for the impairment test are consistent with those utilized by a market participant performing similar valuations for the Company’s reporting units.

Similarly, impairment testing of other intangible assets requires a comparison of carrying value to fair value of that particular asset. Fair values of non-goodwill intangible assets are based primarily on projections of future cash flows to be generated from that asset. For instance, cash flows related to a particular trademark would be based on a projected royalty stream attributable to branded product sales, discounted at rates consistent with rates used by market participants.

 

31


These estimates are made using various inputs including historical data, current and anticipated market conditions, management plans, and market comparables.

Revenue recognition

The Company recognizes sales upon delivery of its products to customers. Revenue, which includes shipping and handling charges billed to the customer, is reported net of applicable provisions for discounts, returns, allowances, and various government withholding taxes. Methodologies for determining these provisions are dependent on local customer pricing and promotional practices, which range from contractually fixed percentage price reductions to reimbursement based on actual occurrence or performance. Where applicable, future reimbursements are estimated based on a combination of historical patterns and future expectations regarding specific in-market product performance. The Company classifies promotional payments to its customers, the cost of consumer coupons, and other cash redemption offers in net sales. The cost of promotional package inserts is recorded in cost of goods sold (COGS). Other types of consumer promotional expenditures are recorded in selling, general and administrative (SGA) expense.

Advertising

The costs of advertising are expensed as incurred and are classified within SGA expense.

Research and development

The costs of research and development (R&D) are expensed as incurred and are classified within SGA expense. R&D includes expenditures for new product and process innovation, as well as significant technological improvements to existing products and processes. The Company’s R&D expenditures primarily consist of internal salaries, wages, consulting, and supplies attributable to time spent on R&D activities. Other costs include depreciation and maintenance of research facilities and equipment, including assets at manufacturing locations that are temporarily engaged in pilot plant activities.

Stock-based compensation

The Company uses stock-based compensation, including stock options, restricted stock and executive performance shares, to provide long-term performance incentives for its global workforce.

The Company classifies pre-tax stock compensation expense principally in SGA expense within its corporate operations. Expense attributable to awards of equity instruments is recorded in capital in excess of par value within the Consolidated Balance Sheet.

Certain of the Company’s stock-based compensation plans contain provisions that accelerate vesting of awards upon retirement, disability, or death of eligible employees and directors. A stock-based award is considered vested for expense attribution purposes when the employee’s retention of the award is no longer contingent on providing subsequent service. Accordingly, the Company recognizes compensation cost immediately for awards granted to retirement-eligible individuals or over the period from the grant date to the date retirement eligibility is achieved, if less than the stated vesting period.

The Company recognizes compensation cost for stock option awards that have a graded vesting schedule on a straight-line basis over the requisite service period for the entire award.

Corporate income tax benefits realized upon exercise or vesting of an award in excess of that previously recognized in earnings (“windfall tax benefit”) is presented in the Consolidated Statement of Cash Flows as a financing activity, classified as “other.” Realized windfall tax benefits are credited to capital in excess of par value in the Consolidated Balance Sheet. Realized shortfall tax benefits (amounts which are less than that previously recognized in earnings) are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense. The Company currently has sufficient cumulative windfall tax benefits to absorb arising shortfalls, such that earnings were not affected during the periods presented. Correspondingly, the Company includes the impact of pro forma deferred tax assets (i.e., the “as if” windfall or shortfall) for purposes of determining assumed proceeds in the treasury stock calculation of diluted earnings per share.

Pension benefits, nonpension postretirement and postemployment benefits

The Company sponsors a number of U.S. and foreign plans to provide pension, health care, and other welfare benefits to retired employees, as well as salary continuance, severance, and long-term disability to former or inactive employees.

The recognition of benefit expense is based on several actuarial assumptions, such as discount rate, long-term rate of compensation increase, long-term rate of return on plan assets and health care cost trend rate, and is reported within COGS and SGA expense on the Consolidated Statement of Income.

The Company recognizes the net overfunded or underfunded position of a defined postretirement benefit plan as a pension asset or pension liability on the Consolidated Balance Sheet. The change in funded status for the year is reported as a component of other comprehensive income (loss), net of tax, in equity.

Obligations associated with the Company’s postemployment benefit plans, which are unfunded, are included in other current liabilities and other liabilities on the Consolidated Balance Sheet.

 

32


Uncertain tax positions

The Company recognizes uncertain tax positions based on a benefit recognition model. Provided that the tax position is deemed more likely than not of being sustained, the Company recognizes the largest amount of tax benefit that is greater than 50 percent likely of being ultimately realized upon settlement. The tax position is derecognized when it is no longer more likely than not of being sustained. The Company classifies income tax-related interest and penalties as interest expense and SGA expense, respectively, on the Consolidated Statement of Income.

Business combinations and noncontrolling interests

In December 2007, the FASB issued separate standards on business combinations and noncontrolling interests in consolidated financial statements. These standards were adopted by the Company at the beginning of its 2009 fiscal year.

For business combinations, the underlying fair value concepts of previous guidance was retained, but the method for applying the acquisition method changed in a number of significant respects including 1) the requirement to expense transaction fees and expected restructuring costs as incurred, rather than including these amounts in the allocated purchase price, 2) the requirement to recognize the fair value of contingent consideration at the acquisition date, rather than the expected amount when the contingency is resolved, 3) the requirement to recognize the fair value of acquired in-process research and development assets at the acquisition date, rather than immediately expensing them, and 4) the requirement to recognize a gain in relation to a bargain purchase price, rather than reducing the allocated basis of long-lived assets. In addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period are recognized in net income rather than as adjustments to the cost of an acquisition, including changes that relate to business combinations completed prior to 2009. To date, the impact of adoption of this standard on the Company’s financial statements has not been significant.

For noncontrolling interests, the consolidated financial statements are presented as if the parent company investors (controlling interests) and other minority investors (noncontrolling interests) in partially-owned subsidiaries have similar economic interests in a single entity. As a result, investments in noncontrolling interests are reported as equity in the consolidated financial statements. Furthermore, the consolidated financial statements include 100% of a controlled subsidiary’s earnings, rather than only the Company’s share. Lastly, transactions between the Company and noncontrolling interests are reported in equity as transactions between shareholders provided that these transactions do not create a change in control. Previously, acquisitions of additional interests in a controlled subsidiary generally resulted in remeasurement of assets and liabilities acquired; dispositions of interests resulted in a gain or loss. The Company’s adoption of this pronouncement changed its presentation of noncontrolling interests.

NOTE 2

ACQUISITIONS, GOODWILL AND OTHER INTANGIBLE ASSETS

Acquisitions

During 2008 and 2007, the Company made acquisitions in order to expand its presence geographically and increase its manufacturing capacity.

Assets, liabilities, and results of operations of the acquired businesses have been included in the Company’s consolidated financial statements beginning on the dates of acquisition; such amounts were insignificant to the Company’s consolidated financial position and results of operations. In addition, the pro forma effect of these acquisitions on the Company’s results of operations, as though these business combinations had been completed at the beginning of 2007, would have been immaterial when considered individually or in the aggregate.

Specialty Cereals.  In September 2008, the Company acquired Specialty Cereals of Sydney, Australia, a manufacturer and distributor of natural ready-to-eat cereals. The Company paid $37 million cash in connection with the transaction, including approximately $5 million to the seller’s lenders to settle debt of the acquired entity. Assets acquired consisted primarily of property, plant and equipment of $19 million and goodwill of $18 million (which will not be deductible for income tax purposes). This acquisition has been included in the Asia Pacific operating segment.

IndyBake Products/Brownie Products.  In August 2008, the Company acquired certain assets and liabilities of the business of IndyBake Products and Brownie Products (collectively, IndyBake), located in Indiana and Illinois. IndyBake, a contract manufacturing business that produced cracker, cookie and frozen dough products, had been a partner to Kellogg for many years as a snacks contract manufacturer.

The Company paid approximately $42 million in cash in connection with the transaction, including approximately $8 million to the seller’s lenders. Assets acquired consisted primarily of property, plant and equipment of $12 million and goodwill of $25 million (which will be deductible for income tax purposes). Other assets acquired amounted to $5 million, net of other liabilities acquired. This acquisition has been included in the North America operating segment.

Navigable Foods.  In June 2008, the Company acquired a majority interest in the business of Zhenghang Food Company Ltd. (Navigable Foods) for

 

33


approximately $36 million (net of cash received). Navigable Foods, a manufacturer of cookies and crackers in the northern and northeastern regions of China, included approximately 1,800 employees, two manufacturing facilities and a sales and distribution network.

During 2008, the Company paid a total of $31 million in connection with the acquisition, including approximately $22 million to lenders and other third parties to settle debt and other obligations of the acquired entity. Assets acquired consisted primarily of property, plant and equipment of $23 million and goodwill of $19 million (which will be deductible for income tax purposes). Other liabilities acquired amounted to $6 million, net of other assets acquired. Additional purchase price payable in June 2011 amounted to $5 million and was recorded on the Company’s Consolidated Balance Sheet in other liabilities as of January 3, 2009. This acquisition has been included in the Asia Pacific operating segment.

The Company recorded noncontrolling interest of $6 million in connection with the acquisition, and obtained the option to purchase the noncontrolling interest beginning June 30, 2011. The noncontrolling interest holder also obtained the option to cause the Company to purchase its remaining interest. The options, which have similar terms, include an exercise price that is expected to approximate fair value on the date of exercise.

United Bakers.  In January 2008, subsidiaries of the Company acquired substantially all of the equity interests in OJSC Kreker (doing business as United Bakers) and consolidated subsidiaries. United Bakers was a leading producer of cereal, cookie, and cracker products in Russia, with approximately 4,000 employees, six manufacturing facilities, and a broad distribution network.

The Company paid $110 million cash (net of $5 million cash acquired), including approximately $67 million to settle debt and other assumed obligations of the acquired entities. Of the total cash paid, $5 million was spent in 2007 for transaction fees and advances. This acquisition has been included in the Europe operating segment.

The purchase agreement between the Company and the seller provides for the payment of a currently undeterminable amount of contingent consideration at the end of three years, which will be calculated based on the growth of sales and earnings before income taxes, depreciation and amortization. Such payment will be recognized as additional purchase price when the contingency is resolved.

 

The purchase price allocation for United Bakers was as follows:

 

(millions)    Asset (liability)  

Cash

   $ 5   

Property, net

     60   

Goodwill (a)

     77   

Working capital, net (b)

     (11

Long-term debt

     (3

Deferred income taxes

     (8

Other

     (5

Total

   $ 115   

 

(a) Goodwill is not expected to be tax deductible.

 

(b) Inventory, receivables and other current assets less current liabilities.

Bear Naked, Inc. and Wholesome & Hearty Foods Company.  In late 2007, the Company completed two separate business acquisitions for a total of approximately $123 million in cash, including related transaction costs. A subsidiary of the Company acquired 100% of the equity interests in Bear Naked, Inc., a leading seller of premium-branded natural granola products. Also, the Company acquired certain assets and liabilities of the Wholesome & Hearty Foods Company, a U.S. manufacturer of veggie foods marketed under the Gardenburger® brand. These acquisitions have been included in the North America operating segment.

Goodwill and other intangible assets

For the periods presented, the Company’s intangible assets consisted of the following:

 

Intangible assets subject to amortization
     

Gross

carrying

amount

   Accumulated
amortization
(millions)    2009    2008    2009    2008

Trademarks

   $ 19    $ 19    $ 15    $ 14

Other

     41      41      30      28

Total

   $ 60    $ 60    $ 45    $ 42

 

      2009    2008

Amortization expense (a)

   $ 3    $ 1

 

(a) The currently estimated aggregate amortization expense for each of the five succeeding fiscal years is approximately $2 million per year.

 

Intangible assets not subject to amortization
      Total carrying
amount
(millions)    2009    2008

Trademarks

   $ 1,443    $ 1,443

 

34


Changes in the carrying amount of goodwill  
(millions)   North
America
  Europe     Latin
America
  Asia
Pacific
(a)
    Consolidated  

December 29, 2007

  $ 3,513   $      $   $ 2      $ 3,515   

Purchase accounting adjustments

    1                       1   

Acquisitions

    25     77            37        139   

Currency translation adjustment

        (16         (2     (18

January 3, 2009

  $ 3,539   $ 61      $   $ 37      $ 3,637   

Currency translation adjustment

        1            5        6   

January 2, 2010

  $ 3,539   $ 62      $   $ 42      $ 3,643   

 

(a) Includes Australia, Asia and South Africa.

NOTE 3

EXIT OR DISPOSAL ACTIVITIES

The Company views its continued spending on cost-reduction initiatives 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.

Cost summary

During 2009, the Company recorded $65 million of costs associated with exit or disposal activities. $44 million represented severance and other cash costs, $3 million was for pension costs, $6 million for asset write offs, and $12 million for other costs including relocation of assets and employees. $40 million of the charges were recorded in cost of goods sold (COGS) in the following operating segments (in millions): North America—$14; Europe—$16; Latin America—$9; and Asia Pacific—$1. $25 million of the charges were recorded in selling, general and administrative (SGA) expense in the following operating segments (in millions): North America—$10; Europe—$13; Latin America—$1; and Asia Pacific—$1.

The Company recorded $27 million of costs in 2008 associated with exit or disposal activities comprised of $7 million of asset write offs, $17 million of severance and other cash costs and $3 million related to pension costs. $23 million of the 2008 charges were recorded in COGS within the Europe operating segment, with the balance recorded in SGA expense in the Latin America operating segment.

For 2007, the Company recorded charges of $100 million, comprised of $7 million of asset write- offs, $72 million for severance and other exit costs including route franchise settlements, $15 million for other cash expenditures, and $6 million for a multiemployer pension plan withdrawal liability. $23 million of the total 2007 charges were recorded in COGS within the Europe operating segment results, with $77 million recorded in SGA expense within the North America operating results.

At January 2, 2010, exit cost reserves were $25 million, related to severance payments which will be made in 2010. Exit cost reserves at January 3, 2009 were $2 million related to severance payments.

Specific initiatives

2009 activities

During 2009, the Company incurred costs related to plans which will result in COGS and SGA expense savings. The COGS programs are Kellogg’s lean, efficient, and agile network (K LEAN), a European manufacturing optimization in Bremen, Germany and a supply chain network rationalization in Latin America. The SGA programs focus on the efficiency and effectiveness of various support functions.

K LEAN seeks to optimize the Company’s global manufacturing network, reduce waste, develop best practices on a global basis and reduce capital expenditures. The Company incurred $24 million of costs for 2009 and expects to incur an additional $14 million in 2010. The charges are primarily for cash payments for severance and other cash costs for asset removal and relocation at various global manufacturing facilities. The above costs impacted operating segments for the year-to-date period, as follows (in millions): North America—$14; Europe—$9; and Asia Pacific—$1.

During 2009, the Company incurred $25 million of costs for SGA programs which will result in an improvement in the efficiency and effectiveness of various support functions. The programs realign these functions to provide greater consistency across processes, procedures and capabilities in order to support the global organization. The Company expects to incur an additional $16 million in 2010 for these programs. The charges represent cash payments for severance and other cash costs associated with the elimination of salaried positions. The above costs impacted operating segments for the year-to-date period, as follows (in millions): North America—$10; Europe—$13; Latin America—$1; and Asia Pacific—$1.

The total costs for these projects, all incurred during the year ended January 2, 2010 were as follows:

 

(millions)   Year-to-date period ended January 2,
2010
  Employee
severance
  Other cash
costs (a)
  Retirement
benefits (b)
  Total

COGS programs

  $ 15   $ 6   $ 3   $ 24

SGA programs

    17     8         25

Total

  $ 32   $ 14   $ 3   $ 49

 

(a) Includes cash costs for equipment removal and relocation.

 

(b) Pension plan curtailment losses and special termination benefits.

 

35


A reconciliation of the severance reserves is as follows:

 

(millions)   Balance
January 3,
2009
  Accruals   Payments     Balance
January 2,
2010

COGS programs

  $   $ 15   $ (9   $ 6

SGA programs

        17     (5     12

Total

  $   $ 32   $ (14   $ 18

The Company incurred $7 million of costs during the year, representing cash payments for severance, related to a manufacturing optimization program in Bremen, Germany. The program will result in future cash savings through the elimination of employee positions and were recorded within COGS in the Europe operating segment. The program was substantially complete as of the end of the third quarter, 2009. Severance reserves were $7 million as of January 2, 2010 which will be paid out during 2010.

The Company incurred $9 million of costs related to a supply chain rationalization in Latin America which resulted in the closing of a plant in Guatemala. The charges represent $3 million of cash payments for severance and other cash costs associated with the elimination of employee positions and $6 million for asset removal and relocation costs as well as non-cash asset write offs. Efficiencies gained in other plants in the Latin America network allow the Company to service the Guatemala market from those plants. The costs were recorded in COGS in the Latin America operating segment and there were no severance reserves as of January 2, 2010.

Prior year activities

During 2008, the Company executed a cost-reduction initiative in Latin America that resulted in the elimination of salaried positions. The cost of the program was $4 million and was recorded in Latin America’s SGA expense. The charge related primarily to severance benefits which were paid in 2008. There were no reserves as of January 3, 2009 related to this program.

The Company commenced a multi-year European manufacturing optimization plan in 2006 to improve utilization of its facility in Manchester, England and to better align production in Europe. The project resulted in an elimination of hourly and salaried positions from the Manchester facility through voluntary early retirement and severance programs. The Company incurred $8 million of expense in 2008, $19 million in 2007 and $28 million in 2006. The pension trust funding requirements of these early retirements exceeded the recognized benefit expense by $5 million which was funded in 2006. During this program certain manufacturing equipment was removed from service. All of the costs for the European manufacturing optimization plan have been recorded in COGS within the Company’s Europe operating segment. All other cash costs were paid in the period incurred. The project was completed in 2008.

In October 2007, management committed to reorganize certain production processes at the Company’s plants in Valls, Spain and Bremen, Germany. Commencement of this plan followed consultation with union representatives at the Bremen facility regarding the elimination of employee positions. The Company incurred $15 million of costs in 2008 and $4 million of costs in 2007. This reorganization plan improved manufacturing and distribution efficiency across the Company’s continental European operations, and was completed as of the end of the Company’s 2008 fiscal year. All of the costs for European production process realignment have been recorded in COGS within the Company’s Europe operating segment.

The following table presents total project costs for the manufacturing optimization and reorganization of production activities. There was a $2 million severance reserve as of the end of January 3, 2009 related to the manufacturing optimization plan. There were no reserves for either program at January 2, 2010.

 

(millions)   Total project costs
  Employee
severance
 

Other

cash

costs
(a)

 

Asset

write-offs

 

Retirement
benefits

(b)

  Total

Manufacturing optimization

  $ 24   $ 13   $ 6   $ 12   $ 55

Reorganization of production

    6     2     11         19

Total

  $ 30   $ 15   $ 17   $ 12   $ 74

 

(a) Includes cash costs for equipment removal and relocation.

 

(b) Pension plan curtailment losses and special termination benefits.

In July 2007, management commenced a plan to reorganize the Company’s direct store-door delivery (DSD) operations in the southeastern United States. This DSD reorganization plan was intended to integrate the Company’s southeastern sales and distribution regions with the rest of its U.S. DSD operations, resulting in greater efficiency across the nationwide network. The Company exited 517 distribution route franchise agreements with independent contractors. The plan also resulted in the involuntary termination or relocation of employee positions. Total project costs incurred were $77 million, principally consisting of cash expenditures for route franchise settlements and to a lesser extent, for employee separation, relocation, and reorganization. This initiative is complete.

 

36


NOTE 4

EQUITY

Earnings per share

Basic net 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 net 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 are comprised principally of employee stock options issued by the Company. The total number of anti-dilutive potential common shares excluded from the reconciliation for each period was (in millions): 2009–12.2; 2008–2.6; 2007–0.8. Basic net earnings per share is reconciled to diluted net earnings per share in the following table:

 

(millions, except per share data)  

Net income
attributable

to Kellogg

Company

  Average
shares
outstanding
 

Net
earnings
per

share

 

2009

     

Basic

  $ 1,212   382   $ 3.17   

Dilutive potential common shares

      2     (.01

Diluted

  $ 1,212   384   $ 3.16   

2008

     

Basic

  $ 1,148   382   $ 3.01   

Dilutive potential common shares

      3     (.02

Diluted

  $ 1,148   385   $ 2.99   

2007

     

Basic

  $ 1,103   396   $ 2.79   

Dilutive potential common shares

      4     (.03

Diluted

  $ 1,103   400   $ 2.76   

Stock transactions

The Company issues shares to employees and directors under various equity-based compensation and stock purchase programs, as further discussed in Note 7. The number of shares issued during the periods presented was (in millions): 2009–3; 2008–5; 2007–4. The Company issued shares totaling less than one million in each of the years presented under Kellogg DirectTM, a direct stock purchase and dividend reinvestment plan for U.S. shareholders.

The Board of Directors authorized stock repurchases of up to $650 million for 2009. During 2009, the Company spent $187 million to purchase approximately 4 million shares of common stock. The unused portion of the 2009 authorization, amounting to $463 million, was rolled over and is available to be executed in 2010. The Board of Directors has authorized an additional stock repurchase program of up to $650 million for 2010. During 2008 and 2007, the Company repurchased $650 million of common stock each year under programs authorized by its Board of Directors. The number of shares repurchased amounted to approximately 13 million and 12 million shares, respectively, in 2008 and 2007.

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 for the periods presented consists of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges and adjustments for net experience losses and prior service cost associated with defined benefit pension and other postretirement plans.

During 2008, the assets of the Company’s postretirement and postemployment benefit plans suffered losses of over $1 billion due to the substantial allocation of assets in the equity market. These losses are recognized in other comprehensive income and for pension plans is recognized in the calculated value of plan assets over a five-year period and once recognized, are amortized using a declining-balance method over the average remaining service period of active plan participants.

 

37


(millions)   Pre-tax
amount
    Tax
(expense)
benefit
    After-tax
amount
 

2009

     

Net income

      $ 1,208   

Other comprehensive income:

     

Foreign currency translation adjustments

  $ 65      $        65   

Cash flow hedges:

     

Unrealized loss on cash flow hedges

    (6     3        (3

Reclassification to net earnings

    (3            (3

Postretirement and postemployment benefits:

     

Amounts arising during the period:

     

Net experience gain (loss)

    161        (72     89   

Prior service cost

    (33     11        (22

Reclassification to net earnings:

     

Net experience loss

    63        (21     42   

Prior service cost

    11        (4     7   
    $ 258      $ (83     175   

Total comprehensive income

                  $ 1,383   

2008

     

Net income

      $ 1,146   

Other comprehensive income:

     

Foreign currency translation adjustments

  $ (431   $        (431

Cash flow hedges:

     

Unrealized loss on cash flow hedges

    (33     12        (21

Reclassification to net earnings

    5        (2     3   

Postretirement and postemployment benefits:

     

Amounts arising during the period:

     

Net experience gain (loss)

    (1,402     497        (905

Prior service cost

    3        (1     2   

Reclassification to net earnings:

     

Net experience loss

    49        (17     32   

Prior service cost

    9        (3     6   
    $ (1,800   $ 486        (1,314

Total comprehensive income

                  $ (168

2007

     

Net income

      $ 1,102   

Other comprehensive income:

     

Foreign currency translation adjustments

  $ 4      $        4   

Cash flow hedges:

     

Unrealized loss on cash flow hedges

    34        (11     23   

Reclassification to net earnings

    5        (1     4   

Postretirement and postemployment benefits:

     

Amounts arising during the period:

     

Net experience gain (loss)

    187        (68     119   

Prior service cost

    7        (4     3   

Reclassification to net earnings:

     

Net experience loss

    89        (30     59   

Prior service cost

    10        (3     7   
    $ 336      $ (117     219   

Total comprehensive income

                  $ 1,321   

 

Accumulated other comprehensive income (loss) at year end consisted of the following:

 

(millions)    2009     2008  

Foreign currency translation adjustments

   $ (771   $ (836

Cash flow hedges — unrealized net loss

     (30     (24

Postretirement and postemployment benefits:

    

Net experience loss

     (1,104     (1,235

Prior service cost

     (61     (46

Total accumulated other comprehensive loss

   $ (1,966   $ (2,141

NOTE 5

LEASES AND OTHER COMMITMENTS

The Company’s leases are generally for equipment and warehouse space. Rent expense on all operating leases was (in millions): 2009-$150; 2008-$145; 2007-$135. During 2008 and 2007, the Company entered into approximately $3 million and $5 million, respectively, in capital lease agreements to finance the purchase of equipment. The Company did not enter into any capital lease agreements during 2009.

At January 2, 2010, future minimum annual lease commitments under noncancelable operating and capital leases were as follows:

 

(millions)    Operating
leases
   Capital
leases
 

2010

   $ 141    $ 2   

2011

     122      1   

2012

     91      1   

2013

     66