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

 
Other

Kellogg Company 10-K 2011
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 1, 2011

 

¨ 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 for purposes of this computation only that the W. K. Kellogg Foundation Trust, directors and executive officers may be affiliates) as of the close of business on July 3, 2010 was approximately $13.7 billion based on the closing price of $50.67 for one share of common stock, as reported for the New York Stock Exchange on that date.

As of January 29, 2011, 365,098,153 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 29, 2011 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 15 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-flavored snacks, frozen waffles and veggie foods. These products were, as of February 25, 2011, 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 2008 through 2010 is located in Note 15 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.

Raw Materials.  Agricultural commodities, including corn, wheat, soy bean 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. We continually monitor world supplies and prices of such commodities (which include such packaging materials), as well as government trade policies. The cost of such commodities may fluctuate widely due to government policy and regulation, weather conditions, climate change 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, Cinnamon Crunch Crispix, Cocoa Krispies, Complete, Kellogg’s Corn Flakes, Corn Pops, Cracklin’ Oat Bran, Crispix, Cruncheroos, Crunchmania, Crunchy Nut, Eggo, Kellogg’s FiberPlus, Froot Loops, Kellogg’s Frosted Flakes, Frosted Krispies, Frosted Mini-Wheats, Fruit Harvest, Just Right, Kellogg’s Low Fat Granola, Mueslix, Pops, Product 19,

 

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Kellogg’s Raisin Bran, Raisin Bran Crunch, Rice Krispies, Rice Krispies Treats, Smacks/Honey Smacks, Smart Start, Kellogg’s Smorz, Special K and Special K Red Berries in the United States and elsewhere; Zucaritas, Choco Zucaritas, Crusli, Sucrilhos, Vector, Musli, NutriDia, and Choco Krispis for cereals in Latin America; Vive and Vector in Canada; Coco Pops, Chocos, Frosties, 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, Komplete for biscuits; and Kaos for snacks in Mexico and elsewhere in Latin America; Pop-Tarts and Pop-Tarts Ice Cream Shoppe for toaster pastries; Pop-Tarts Mini Crisps for crackers; Eggo, Eggo FiberPlus, 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 for flavored protein water mixes and protein shakes; 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, Austin, Keebler Baker’s Treasures, Cheez-It, Chips Deluxe, Club, E. L. Fudge, Famous Amos, Fudge Shoppe, Hi-Ho, Kellogg’s FiberPlus, Gripz, Jack’s, Jackson’s, Krispy, Mother’s, Murray, Murray Sugar Free, Ready Crust, Right Bites, Sandies, Special K, Soft Batch, Stretch Island, Sunshine, Toasteds, Town House, Vienna Creams, Vienna Fingers, Wheatables and Zesta. One of our subsidiaries is also the exclusive licensee of the Carr’s cracker 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 cereal; Dig ‘Em for Smacks/Honey Smacks cereal; Sunny for Kellogg’s Raisin Bran and Raisin Bran Crunch cereals, Coco the Monkey for Coco Pops cereal; Cornelius for Kellogg’s Corn Flakes; Melvin the Elephant for certain cereal and convenience foods; Chocos the Bear, Kobi the Bear, Sammy the Seal (aka Smaxey 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 2010, comprised principally of sales within the United States. At January 1, 2011, approximately 18% of our consolidated receivables balance and 27% 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 2010. During 2010, our top five customers, collectively, including Wal-Mart, accounted for approximately 34% of our consolidated net sales and approximately 46% 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 1, 2011 and January 2, 2010 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 $187 million in 2010 and $181 million in 2009 and 2008.

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 release 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 1, 2011, we had approximately 30,600 employees.

Financial Information About Geographic Areas. Information on geographic areas is located in Note 15 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 25, 2011) 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

    64   

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.

 

John A. Bryant

    45   

President and Chief Executive Officer

 

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Mr. Bryant became President and Chief Executive Officer on January 2, 2011 and has served as a Kellogg director since July 2010. 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

    57   

Senior Vice President, Global Public Policy and External Relations, Chief Sustainability Officer

Dr. Clark has been Kellogg Company’s senior vice president, global public policy and external relations since August 2010. 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. In June 2006, Dr. Clark was appointed Kellogg’s Senior Vice President of Global Nutrition and Corporate Affairs. Since 2008, Dr. Clark has served as the company’s Chief Sustainability Officer.

 

Bradford J. Davidson

    50   

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

    52   

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, Mr. Dissinger became Vice President, Corporate Financial Planning, and CFO, Kellogg International. In 2005, he became Vice President and CFO, Kellogg Europe and CFO, Kellogg International. In 2007, Mr. Dissinger was appointed Senior Vice President and Chief Financial Officer, Kellogg North America.

 

Paul T. Norman

    46   

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. From 1989 to 1996, Mr. Norman was promoted to several marketing roles in France and Canada. He was 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

    46   

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

    55   
Senior Vice President, Global Human Resources  

 

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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

    55   
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 49016-9935 (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,” “can,” “anticipate,” “estimate,” “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 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 food safety, advertising and labeling laws and regulations; the ultimate impact of product recalls; business disruption or other losses from war, terrorist acts, or political unrest; other items; 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.

 

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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 and currency restrictions 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, Mexican peso, Venezuelan bolivar fuerte and Russian ruble. 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 unpredictably and 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 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, misbranded or mislabeled, 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, allergens, 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 June

 

6


2010, we initiated a recall of certain ready-to-eat cereals due to an odor from waxy resins used to make package liner. 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, including any potential effects of climate change, 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, labeling, 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 impose additional regulatory requirements. Those regulations control such matters as food quality and safety, ingredients, advertising, labeling, 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 divestiture 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

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

 

7


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. Most 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 1, 2011, we had total debt of approximately $5.9 billion and total equity of $2.2 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 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

 

8


consolidated net sales during 2010, comprised principally of sales within the United States. At January 1, 2011, approximately 18% of our consolidated receivables balance and 27% 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 2010. During 2010, our top five customers, collectively, including Wal-Mart, accounted for approximately 34% of our consolidated net sales and approximately 46% 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 1, 2011, 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 $11.8 billion and total equity of $2.2 billion. An impairment charge of $20 million was recognized in 2010 representing all of the goodwill from our 2008 acquisition of a business in China.

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 effect 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 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.

 

9


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 25, 2011, 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 and Zanesville, Ohio; Muncy, Pennsylvania; Rossville, Tennessee; Clearfield, Utah; and Allyn, Washington.

Outside the United States, we had, as of February 25, 2011, 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, audits 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. [RESERVED]

 

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 14 within Notes to Consolidated Financial Statements.

On April 23, 2010, the Company’s board of directors authorized a $2.5 billion three-year share repurchase program for 2010 through 2012 for general corporate purposes and to offset issuances for employee benefit programs. During 2010, the Company repurchased 21 million shares for a total of $1,057 million, of which $1,052 million was paid during the year and $5 million was payable at January 1, 2011.

The following table provides information with respect to purchases of common shares under programs authorized by the Company’s board of directors during the quarter ended January 1, 2011.

 

(millions, except per share data)                
Period  

(a)

Total
Number
of

Shares
Purchased

    (b)
Average
Price
Paid Per
Share
   

(c)

Total
Number

of Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs

   

(d)

Approximate

Dollar

Value of
Shares

that May

Yet Be
Purchased
Under the
Plans or
Programs

 

Month #1:
10/3/10 -10/30/10

        $ 0.00            $ 1,593   

Month #2:
10/31/10 -11/27/10

        $ 0.00            $ 1,593   

Month #3:
11/28/10 -1/1/11

    3.0     $ 50.13        3.0     $ 1,443   

Total

    3.0     $ 50.13        3.0          

 

11


ITEM 6. SELECTED FINANCIAL DATA

Kellogg Company and Subsidiaries

Selected Financial Data

 

(millions, except per share data and number of employees)    2010     2009     2008     2007     2006  

Operating trends (a) 

          

Net sales

   $ 12,397     $ 12,575     $ 12,822     $ 11,776     $ 10,907  

Gross profit as a % of net sales

     42.7     42.9     41.9     44.0     44.2

Depreciation

     370       381       374       364       351  

Amortization

     22       3       1       8       2  

Advertising expense

     1,130       1,091       1,076       1,063       916  

Research and development expense

     187       181       181       179       191  

Operating profit

     1,990       2,001       1,953       1,868       1,766  

Operating profit as a % of net sales

     16.1     15.9     15.2     15.9     16.2

Interest expense

     248       295       308       319       307  

Net income attributable to Kellogg Company

     1,247       1,212       1,148       1,103       1,004  

Average shares outstanding:

          

Basic

     376       382       382       396       397  

Diluted

     378       384       385       400       400  

Per share amounts:

          

Basic

     3.32       3.17       3.01       2.79       2.53  

Diluted

     3.30       3.16       2.99       2.76       2.51  

Cash flow trends

          

Net cash provided by operating activities

   $ 1,008     $ 1,643     $ 1,267     $ 1,503     $ 1,410  

Capital expenditures

     474       377       461       472       453  

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

     534       1,266       806       1,031       957  

Net cash used in investing activities

     (465     (370     (681     (601     (445

Net cash used in financing activities

     (439     (1,182     (780     (788     (789

Interest coverage ratio (c)

     9.6       8.0       7.5       7.0       6.9  

Capital structure trends

          

Total assets

   $ 11,847     $ 11,200     $ 10,946     $ 11,397     $ 10,714  

Property, net

     3,128       3,010       2,933       2,990       2,816  

Short-term debt and current maturities of long-term debt

     996       45       1,388       1,955       1,991  

Long-term debt

     4,908       4,835       4,068       3,270       3,053  

Total Kellogg Company equity (d)

     2,158       2,272       1,448       2,526       2,069  

Share price trends

          

Stock price range

   $ 47-56      $ 36-54      $ 40-59      $ 49-57      $ 42-51   

Cash dividends per common share

     1.560       1.430       1.300       1.202       1.137  

Number of employees

     30,645       30,949       32,394       26,494       25,856  

 

(a) Fiscal year 2008 contained a 53rd week. Refer to Note 1 for further information.

 

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

 

(c) Interest coverage ratio is calculated based on net 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-flavored 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 3 to 4% 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 the Foreign currency translation section for a discussion and reconciliation of currency neutral EPS, a non-GAAP measure.

For our full year 2010, internal and reported net sales were down 1%. Consolidated internal operating profit was flat compared to the prior year. Reported operating profit decreased 1%. Diluted EPS increased 6% on a currency neutral basis. Reported EPS was $3.30, an increase of 4% over last year’s $3.16.

 

Consolidated results
(dollars in millions, except
per share data)
  2010     2009     2008  

Net sales

  $ 12,397     $ 12,575     $ 12,822  

Net sales growth:

  As reported     (1.4 )%      (1.9 )%      8.9
   

Internal (a)

    (1.3 )%      3.0     5.4

Operating profit

  $ 1,990     $ 2,001     $ 1,953  

Operating profit growth:

  As reported     (0.6 )%      2.5     4.5
   

Internal (a)

    (0.1 )%      10.3     4.2

Diluted net earnings
per share (EPS)

  $ 3.30     $ 3.16     $ 2.99  

EPS growth (b)

    4     6     8

Currency neutral diluted EPS growth (b)

    6     13     8

 

(a)

Internal net sales and operating profit growth for 2010 exclude the impact of currency. Internal net sales and operating profit growth 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 growth are non-GAAP financial measures which are further discussed and reconciled to the directly comparable measures in accordance with U.S. GAAP in the Net sales and operating profit section.

 

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

While 2010 was a difficult year, we have taken actions to regain momentum in 2011. We believe we can achieve our objectives through increased innovation and investments in brand building initiatives. Kellogg has over a 100 year heritage with strong brands. In combination with an attractive dividend yield, we believe our business model will provide a strong total return to our shareholders.

 

13


Net sales and operating profit

2010 compared to 2009

The following table provides an analysis of net sales and operating profit performance for 2010 versus 2009:

 

(dollars in millions)   North
America
    Europe     Latin
America
    Asia
Pacific
(a)
    Corporate     Consolidated  

2010 net sales

    $8,402       $2,230       $923       $842       $—        $12,397  

2009 net sales

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

% change — 2010 vs. 2009:

           

Volume (tonnage) (b)

    (2.5 )%      (2.4 )%      (3.4 )%      4.3            (2.1 )% 

Pricing/mix

    .6     (.3 )%      8.2     (2.3 )%             .8

Subtotal — internal business

    (1.9 )%      (2.7 )%      4.8     2.0            (1.3 )% 

Foreign currency impact

    .6     (2.8 )%      (8.9 )%      11.7            (.1 )% 

Total change

    (1.3 )%      (5.5 )%      (4.1 )%      13.7            (1.4 )% 
           
(dollars in millions)   North
America
    Europe     Latin
America
    Asia
Pacific
(a)
    Corporate     Consolidated  

2010 operating profit

    $1,554       $364       $153       $74       $(155)        $1,990  

2009 operating profit

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

% change — 2010 vs. 2009:

           

Internal business

    (1.7 )%      8.2     (2.4 )%      (29.5 )%      14.2     (.1 )% 

Foreign currency impact

    .7     (3.4 )%      (12.3 )%      15.2            (.5 )% 

Total change

    (1.0 )%      4.8     (14.7 )%      (14.3 )%      14.2     (.6 )% 

 

(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.

Our consolidated net sales were down 1% on both a reported and internal basis. There were four major issues that affected our results. First, our categories respond to innovation and brand building. We did not have sufficient cereal innovations in 2010. Rather, we focused on renovating our existing cereal products. We invested in renovation to improve the nutritional profile of our products. For 2011, we have a stronger innovation pipeline to drive top-line growth. Secondly, we experienced supply chain disruptions in our waffle business and had a second quarter recall of select packages of breakfast cereals. As a result, we have increased investment in our supply chain to mitigate potential risks. Next, we experienced weakness in our core cereal businesses in both measured and non-measured channels. Lastly, the competitive environment drove price deflation into the cereal category. In late 2010 we announced price increases driven by higher input costs on many products across our categories around the world.

Internal net sales for our North America operating segment declined 2%. North America has three product groups: retail cereal, retail snacks and frozen and specialty channels. Retail cereal’s internal net sales declined by 5% on a full-year basis. Our consumption was negatively impacted by the impact of the cereal recall that occurred in the second quarter of 2010. The brands involved in the recall were the cornerstone of our back-to-school promotions in the third quarter. Promotional pricing drove deflation into the category, but did not drive higher category volumes as would be expected. The U.S. cereal category responds well to innovation. While there were lower levels of innovation across the category in 2010, our innovations performed well. We have also been impacted by less support from non-measured channels this year. Trade inventory levels at the end of 2009 were higher than normal. As a result, our 2010 sales were negatively impacted as retailers sold through their inventory, reducing their purchases from us.

The retail snack product group (cookies, crackers, toaster pastries, cereal bars, and fruit-flavored snacks) grew by 1%. The modest growth was driven by Pop-Tarts® and strong wholesome snack sales including our bar innovations such as FiberPlus® and Special K Fruit Crisps®. The strong performance in wholesome snacks was masked by weaker performance in cookies and to a lesser extent crackers. We were able to maintain our cracker category share in measured channels despite increased competitive promotional activity. Consumption in the cookie category was down for the year. Our cookie performance was also impacted by the loss of shelf space in non-measured channels, which we were able to regain during the fourth quarter of 2010.

Internal net sales in the frozen and specialty channels (frozen foods, food service and vending) decreased by 3%. Our sales were negatively impacted during the year due to the waffle supply disruption that began late in 2009. We have returned to full capacity and have introduced new innovations. While the business rebounded slower than expected during 2010 as it took longer to rebuild and reset retailer shelves, we have reinstated brand building and the business is responding positively. Our veggie business continues to perform well, particularly Morningstar Farms® burgers and entrees. Our food service business grew during the year, continuing to outperform the industry.

Our International operating segments’ internal net sales were flat compared to the prior year. Europe’s internal net sales declined 3% for the year. The cereal category (as measured by consumption) declined in our core European countries such as the U.K. Additionally, we saw price deflation in many food categories across Europe, especially in the U.K. Continued weakness in the Russia snack business drove lower volumes and contributed to Europe’s lower top line results. We worked to stabilize the bulk business while introducing packaged snacks in Russia. Latin America’s internal net sales growth was 5%. The growth in cereal masked the decline in snacks. Our decline in snacks was largely driven by Venezuela where we import some products from Mexico. The imports were impacted by exchange rate controls and it is no longer cost efficient to import goods. Internal

 

14


net sales in Asia Pacific grew 2% driven by strong performance across most of Asia, as well as South Africa. This was muted by a decline in Australia where the cereal category faced price deflation.

Consolidated operating profit declined by 1% on an as reported basis and was flat on an internal basis, when excluding the impact of foreign currency translation. Operating profit for the year was negatively impacted by the cereal recall, higher than expected commodity inflation and investments in our supply chain. Operating profit benefited from lower incentive compensation expense. Incentive compensation is based upon the Company’s actual results compared to our target. Given results were lower than our targets, which were set at the beginning of 2010, incentive compensation decreased significantly compared to the prior year. Despite 2010’s operating performance, we recognized the need to invest in advertising. Accordingly, we increased our spending in advertising by 4%, excluding the impact of foreign currency translation.

Internal operating profit in North America decreased by 2%, Europe’s grew by 8%, Latin America’s declined by 2% and Asia Pacific’s declined by 30%. North America’s decline was attributable to lower sales in our U.S. cereal business. Competitive activity drove lower cereal sales as did the second quarter cereal recall. These negative drivers were partially offset by lower incentive compensation expense and decreased spending on cost reduction initiatives. Europe’s operating profit increased due to lower commodity costs and less spending on cost reduction initiatives. The decline in Latin America’s operating profit is primarily a result of higher commodity costs. Asia Pacific’s operating profit was negatively impacted by the impairment charges related to our business in China. Refer to Note 2 within Notes to Consolidated Financial Statements for further information. Corporate benefited from lower incentive compensation expense.

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 2009 consolidated reported net sales were down compared to the prior 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 2008’s strong 5% growth. While overall volume declined, we achieved internal net 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 started moving our businesses away from lower margin products 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 2008. 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

 

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channels, which includes frozen foods, food service and vending, dampened net sales for the year, with a decline in net sales of 1%.

We experienced broad based growth in retail snacks, with sales growth of 3%. Pop-Tarts® performed well as 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 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% 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 started to see recovery in 2009, it was slower than the commercial sectors such as hotels and restaurants. We were also experiencing a supply disruption

in our waffle facilities. We made improvements in our facilities and worked 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 2009. While our plants were operational at the end of 2009, they were not running at their previous level of capacity. Demand continued to exceed supply.

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 during the year. We encountered some retailer disputes earlier in 2009 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 increased 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 53rd week in 2009. In 2009, we continued to experience cost pressures, increased our spending on cost reduction initiatives, 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 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 reported 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.

Margin performance

Margin performance was as follows:

 

                          Change vs.
prior year (pts.)
 
    2010       2009       2008       2010       2009  

Gross margin (a)

    42.7     42.9     41.9     (.2     1.0  

SGA% (b)

    (26.6 )%      (27.0 )%      (26.7 )%      .4       (.3

Operating margin

    16.1     15.9     15.2     .2       .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.

As illustrated in the preceding table, our consolidated gross margin declined by 20 basis points in 2010 due to the cereal recall, increased cost pressures for fuel, energy, commodities and employee benefits and supply chain investments, which were more than offset by savings from cost reduction initiatives and lower up-front costs recorded in cost of sales (COGS). Our selling, general and administrative (SGA) expense as a percentage of net sales decreased by 40 basis points primarily due to a reduction in incentive compensation expense and lower costs for cost reduction initiatives, which more than offset increased advertising investment and a goodwill impairment.

Our consolidated gross margin increased by 100 basis points in 2009. Acquisitions lowered gross margin by approximately 10 basis points. We experienced inflationary cost pressures for fuel, energy, commodities and employee benefits. During 2009, 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 SGA expense as a percentage of net sales increased slightly due to higher costs for cost reduction initiatives of $17 million recorded in overhead as well as an increase in advertising spend.

 

16


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.

Volatility in the foreign exchange markets has limited our ability to forecast future U.S. dollar reported earnings. As such, we are measuring diluted earnings per share growth and providing guidance on future earnings 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 useful measurement of comparability given the volatility in foreign exchange markets.

Below is a reconciliation of reported EPS to currency neutral EPS for the fiscal years 2010, 2009 and 2008:

 

Consolidated results    2010     2009     2008  

Diluted net earnings per share (EPS)

   $ 3.30     $ 3.16     $ 2.99  

Translational impact (a)

     0.04       0.22         

Currency neutral EPS

   $ 3.34     $ 3.38     $ 2.99  

Currency neutral EPS growth (b)

     6     13     8

 

(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, if applicable.

 

(b) Calculated as a percentage of growth from the prior year’s 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.

We incurred costs that qualify as exit costs under U.S. generally accepted accounting principles. Refer to Note 3 within Notes to Consolidated Financial Statements for further detail on our exit or disposal plans.

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. The savings challenge began in 2009 with a goal of achieving $1 billion of savings by the end of 2011. These initiatives are integral to meeting our savings challenge.

Other cost reduction initiatives

2010 activities

In addition to exit costs, 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 that are discussed in further detail in Note 3 within Notes to Consolidated Financial Statements.

Costs incurred in fiscal year 2010 as well as total program costs are as follows:

 

(millions)

  For the year ended
January, 1 2011
    Total program costs through
January, 1 2011
 
  COGS
programs
    SGA
programs
    Total     COGS
programs
    SGA
programs
    Total  

North America

  $ 17     $ 1     $ 18     $ 67      $ 14     $ 81  

Europe

    10       1       11       20        3       23  

Latin America

    3              3       8               8  

Asia Pacific

    3              3       8               8  

Corporate

           3       3              3       3  

Total

  $ 33     $ 5     $ 38     $ 103      $ 20     $ 123  

The additional cost and cash outlay in 2011 for these programs, excluding exit costs, is estimated to be $5 to $10 million.

SAP reimplementation

We are reimplementing SAP which will result in process and productivity improvements. The program is expected to require approximately $70 million of expense, in addition to capital investments. We are incurring incremental consulting costs associated with the reimplementation, which will begin in 2011.

During 2010, we incurred approximately $9 million of cash consulting costs associated with the SAP reimplementation. The costs were recorded in SGA expense within the North America operating segment for $8 million and the Latin America operating segment for $1 million. The additional cost and cash outlay in 2011 and 2012 for this program, is estimated to be $60 million. This program is not included in the table above.

 

17


Prior year activities

During 2009, we incurred $73 million of costs related to our on-going COGS and SGA programs. These represent cash costs for consulting and other charges. The costs by program and segment were as follows (in millions):

 

(millions)

   For the year ended,
January 2, 2010
 
   COGS
programs
     SGA
programs
     Total  

North America

   $ 38      $ 13      $ 51  

Europe

     10        2        12  

Latin America

     5                5  

Asia Pacific

     5                5  

Total

   $ 58      $ 15      $ 73  

Interest expense

As illustrated in the following table, annual interest expense for the 2008 to 2010 periods has trended downward. The decline in 2010 was due primarily to costs incurred in 2009 for early redemption of long-term debt and lower interest rates on our long-term debt. Interest income (recorded in other income (expense), net) was (in millions), 2010-$6; 2009-$4; 2008-$20. The decline for 2009 was primarily due to a drop in average interest rates. We currently expect that our 2011 gross interest expense will be approximately $235 to $245 million.

 

                            Change vs. prior  
year
 
(dollars in millions)   2010     2009     2008     2010     2009  

Reported interest
expense (a)

  $ 248     $ 295     $ 308      

Amounts capitalized

    2       3       6                  

Gross interest expense

  $ 250     $ 298     $ 314       (16.1 )%      (5.1 )% 

 

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

Income taxes

Our reported effective tax rates for 2010, 2009 and 2008 were 28.8%, 28.2% and 29.7% respectively. The impact of discrete adjustments and the cost of remitted and unremitted foreign earnings reduced our effective income tax rate by 3 percentage points for 2010. For 2009 and 2008, the impact was a reduction of 2% and 1% respectively. Refer to Note 10 within Notes to Consolidated Financial Statements for further information. For 2011, we expect our consolidated effective income tax rate to be approximately 30%. Fluctuations in foreign currency exchange rates could impact the expected effective income tax rate as it is dependent upon U.S. dollar earnings of foreign subsidiaries doing business in various countries with differing statutory tax rates. Additionally, the rate 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.

Product withdrawal

Refer to Note 12 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.

The following table sets forth a summary of our cash flows:

 

(millions)    2010     2009     2008  

Net cash provided by (used in):

  

   

Operating activities

   $ 1,008     $ 1,643     $ 1,267  

Investing activities

     (465     (370     (681

Financing activities

     (439 )     (1,182 )     (780 )

Effect of exchange rates on cash and cash equivalents

     6        (12     (75

Net increase (decrease) in cash and cash equivalents

   $ 110      $ 79      $ (269

Operating activities

The principal source of our operating cash flows is net earnings, meaning cash receipts from the sale of our products, net of costs to manufacture and market our products.

Our net cash provided by operating activities for 2010 amounted to $1,008 million, a decrease of $635 million compared with 2009. The reduction in net cash provided by operating activities was primarily attributable to higher pension and postretirement benefit plan contributions and increased payments for advertising and promotion in 2010. Our net cash provided by operating activities for 2009 amounted to $1,643 million, an increase of $376 million compared with 2008, reflecting lower pension and postretirement benefit plan contributions and the impact of lower payments for advertising and promotion in 2009.

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 2010, 23 days for 2009, and 22 days for 2008. During 2010, the impact of

 

18


higher days of inventory outstanding was offset by an increase in days of trade payables outstanding. Days of inventory outstanding reflected the higher levels needed to improve order fill levels, along with the impact of lower reported sales in 2010. Core working capital in 2010 averaged 6.6% of net sales, compared to 6.5% in the prior year. The increase in 2009’s cash conversion cycle was the result of a decrease in days of trade payables outstanding, which led to a 30 basis point increase in core working capital as an average of net sales in 2009 compared with 2008.

Our total pension and postretirement benefit plan funding amounted to $643 million, $100 million and $451 million, in 2010, 2009 and 2008, respectively.

During the fourth quarter of 2010, we made incremental contributions to our pension and postretirement benefit plans amounting to $563 million ($467 million, net of tax). We also made additional plan contributions amounting to $400 million in the fourth quarter of 2008, after adverse conditions in the equity markets caused 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%.

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 2017 or beyond. 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 quality corporate bonds and our decisions regarding certain elective provisions of the PPA.

We currently project that we will make total U.S. and foreign benefit plan contributions in 2011 of approximately $200 million. Actual 2011 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)    2010     2009     2008  

Net cash provided by operating activities

   $ 1,008     $ 1,643     $ 1,267  

Additions to properties

     (474     (377     (461

Cash flow

   $ 534     $ 1,266     $ 806  

year-over-year change

     (57.8 )%      57.1        

Year-over-year changes in cash flow (as defined) were driven by variations in the amount of contributions to our pension and postretirement benefit plans and changes in the level of capital expenditures during the three-year period.

For 2011, we are expecting cash flow (as defined) to be $1.1 billion to $1.2 billion, which reflects the impact of 2011 expected pension contributions, net of tax.

Investing activities

Our net cash used in investing activities for 2010 amounted to $465 million, an increase of $95 million compared with 2009 due to a higher level of capital expenditures in 2010.

Capital spending in 2010 included investments in our information technology infrastructure related to the reimplementation and upgrade of our SAP platform and investments in our supply chain. 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.

Net cash used in investing activities of $370 million in 2009 decreased by $311 million compared with 2008, reflecting a reduction in business acquisition activity, and to a lesser extent, 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. 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 3.8% in 2010, 3.0% in 2009, and 3.6% in 2008.

We anticipate spending approximately 4% of net sales for additions to properties in 2011. In addition to continuing to invest in our supply chain and information technology infrastructure, our spending will also focus on increasing capacity to facilitate growth and innovation.

 

19


Financing activities

Our net cash used in financing activities for 2010, 2009 and 2008 amounted to $439 million, $1,182 million, and $780 million, respectively.

Total debt was $5.9 billion at year-end 2010 and $4.9 billion at year-end 2009. In December 2010, we issued $1.0 billion of ten-year 4.0% fixed rate U.S. Dollar Notes, using a portion of the $987 million net proceeds to make incremental pension and postretirement benefit plan contributions. The proceeds were also used to retire commercial paper. Taking into consideration the impact of hedge settlements and the issuance discount, the effective interest rate on the notes issued in December 2010 is 3.42%.

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 of the 2011 debt, which had an effective interest rate of 7.08%, through a tender offer. In connection with the debt retirement, we recognized $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 2009 cash flows from operating activities.

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%.

We repurchased approximately 21 million shares of our common stock in 2010 for $1.1 billion under a share repurchase program authorized by our board of directors in April 2010. This program authorized repurchases of our common stock amounting to $2.5 billion during 2010 through 2012. This three year authorization replaced a previous share buyback program which had authorized stock repurchases of up to $1.1 billion for 2010.

During 2011 and 2012, we plan to execute the remaining repurchases under the 2010 authorization, with projected purchases of $800 million in 2011 and the balance in 2012. We expect 2011 average shares outstanding to decline by 4 percent compared with 2010. Actual repurchases could be different from our current projections, as influenced by factors such as changes in our stock price and other competing priorities.

During 2009, we spent $187 million to repurchase 4 million of our shares while in 2008 we spent $650 million to repurchase 13 million shares. Our Board of Directors had authorized annual stock repurchases of up to $650 million for 2009 and 2008. In addition, a separate $500 million share repurchase authorization received Board approval in 2008. We made no repurchases under this authorization, which was later terminated, because we decided to use cash to fund pension and postretirement benefit plans and reduce commercial paper.

We paid quarterly dividends to shareholders totaling $1.56 per share in 2010, $1.43 per share in 2009 and $1.30 per share in 2008. Total cash paid for dividends increased by 7.0% in 2010 and 10.3% in 2009. 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 November 2011. Under this facility, 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. We are in the process of entering into a new credit agreement that will replace the existing agreement.

We plan to use commercial paper to refinance our $946 million of debt maturing in the first quarter of 2011.

 

20


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 were not affected by the changes in the credit environment.

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.

 

OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

Off-balance sheet arrangements

As of January 1, 2011 and January 2, 2010 we did not have any material off-balance sheet arrangements.

Contractual obligations

The following table summarizes our contractual obligations at January 1, 2011:

 

Contractual obligations    Payments due by period  
(millions)    Total      2011      2012      2013      2014      2015      2016 and
beyond
 

Long-term debt:

                    

Principal

   $ 5,808      $ 946      $ 750      $ 752      $ 8      $ 1      $ 3,351  

Interest (a)

     2,960        278        259        221        216        216        1,770  

Capital leases (b)

     5        1        1        1        1                1  

Operating leases (c)

     585        149        126        94        66        47        103  

Purchase obligations (d)

     759        632        47        37        17        15        11  

Uncertain tax positions (e)

     43        43                                          

Other long-term obligations (f)

     625        135        60        59        73        76        222  

Total

   $ 10,785      $ 2,184      $ 1,243      $ 1,164      $ 381      $ 355      $ 5,458  

 

(a) Includes interest payments on our long-term debt and payments on our interest rate swaps. Interest calculated on our variable rate debt was forecasted using the LIBOR forward rate curve as of January 1, 2011.

 

(b) The total expected cash payments on our capital leases include interest expense totaling approximately $1 million over the periods presented above.

 

(c) Operating leases represent the minimum rental commitments under non-cancelable operating leases.

 

(d) Purchase obligations consist primarily of fixed commitments for raw materials to be utilized in the normal course of business and for marketing, advertising and other services. The amounts presented in the table do not include items already recorded in accounts payable or other current liabilities at year-end 2010, 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.

 

(e) As of January 1, 2011, our total liability for uncertain tax positions was $104 million, of which $43 million, is expected to be paid in the next twelve months. We are not able to reasonably estimate the timing of future cash flows related to the remaining $61 million.

 

(f) Other long-term obligations are those associated with noncurrent liabilities recorded within the Consolidated Balance Sheet at year-end 2010 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 2016 as follows: 2011-$55; 2012-$38; 2013-$38; 2014-$59; 2015-$50; 2016-$51. While the table reflects the estimated minimum plan contributions, it does not include the total planned contributions to U.S. and foreign benefit plans. For 2011, we are currently projecting that we will make total benefit plan contributions of approximately $200 million.

 

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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 2010 net sales; therefore, it is likely that our results would be materially different if different assumptions or conditions were to prevail.

Property

Long-lived assets such as property, plant and equipment are tested for impairment when conditions indicate that the carrying value may not be recoverable. Management evaluates several conditions, including, but not limited to, the following: a significant decrease in the market price of an asset or an asset group; a significant adverse change in the extent or manner in which a long-lived asset is being used, including an extended period of idleness; and a current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. For assets to be held and used, we project the expected future undiscounted cash flows generated by the long-lived asset or asset group over the remaining useful life of the primary asset. If the cash flow analysis yields an amount less than the carrying amount we determine the fair value of the asset or asset group by using comparable market data. There are inherent uncertainties associated with the judgments and estimates we use in these analyses.

At January 1, 2011, we have property plant and equipment of $3.1 billion, net of accumulated depreciation, on our balance sheet. Included in this amount are approximately $70 million of idle assets. The largest individual idle asset is a facility outside the United States which we tested for impairment on a held and used basis. The estimated future undiscounted cash flows exceeded the net book value of the facility as of January 1, 2011. Management estimates the plant will be deployed within the next several years. Should management’s plan for deployment change, this could result in an impairment charge of up to $50 million based on the current carrying value.

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 2010 goodwill impairment test, the fair value of the reporting units was estimated based on market multiples. Our approach employs market multiples based on earnings before interest, taxes, depreciation and amortization, earnings for companies comparable to our reporting units and discounted cash flows. 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 indefinite-lived 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 with a finite life is expected to contribute directly or indirectly to the cash flows of the Company. 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 1, 2011, 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

 

22


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 1, 2011, 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. Additionally, we have $62 million of goodwill related to our 2008 acquisition of United Bakers in Russia. The percentage of excess fair value over carrying value of the Russian reporting unit declined in 2010 from an excess of 100% to an excess of 30%. The year-over-year decline was attributable to lower margins resulting from our strategy to stabilize the bulk snack business, while introducing packaged snacks, as well as reintroducing cereal into the market. If we used modestly different assumptions regarding sales multiples and earnings before income taxes, depreciation and amortization (EBITDA) in the valuation, this could have resulted in an impairment loss. For example, if our projection of EBITDA margins had been lower by 200 basis points, this change in assumption may have resulted in impairment of some or all of the goodwill in the Russian reporting unit. Management will continue to monitor the situation closely.

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 69% 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 2010 of 8.9% equated to approximately the 62nd percentile expectation of our 2010 model. Similar methods are used for various foreign plans with invested assets, reflecting local economic conditions. Foreign trust investments represent approximately 31% of our global benefit plan assets.

Based on consolidated benefit plan assets at January 1, 2011, a 100 basis point reduction in the assumed rate of return would increase 2011 benefits expense by approximately $50 million. Correspondingly, a 100 basis point shortfall between the assumed and actual rate of return on plan assets for 2011 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 13 years. Under this recognition method, a 100 basis point shortfall in actual versus assumed performance of all of our plan assets in 2011 would reduce pre-tax earnings by approximately $1.7 million in 2012, increasing to approximately $8.5 million in 2016. 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): 2010-$208; 2009–$507; 2008–$(1,528).

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.

 

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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 0.8%, our initial trend rate for 2011 of 6.6% 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 1, 2011, a 100 basis point increase in the assumed health care cost trend rates would increase 2011 benefits expense by approximately $19 million. A 100 basis point excess of 2011 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 2010 claims experience was approximately $36 million.

To conduct our annual review of discount rates, we selected the discount based on a cash-flow matching analysis using Towers Watson’s proprietary RATE:Link tool and projections of the future benefit payments constituting the projected benefit obligation for the plans. Prior to 2010, we employed a similar methodology, but used the spot yield curve underlying the Citigroup Index. There was no material difference in the discount rate resulting from the change. RATE:Link establishes the uniform discount rate that produces the same present value of the estimated future benefit payments, as is generated by discounting each year’s benefit payments by a spot rate applicable to that year. The spot rates used in this process are derived from a yield curve created from yields on the 40th to 90th percentile of U.S. high quality bonds. A similar methodology is applied in Canada and Europe, except the smaller bond markets imply that yields between the 10th and 90th percentiles are preferable. 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 1, 2011, a 25 basis point decline in the weighted-average discount rate used for benefit plan measurement purposes would increase 2011 benefits expense by approximately $15 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 1, 2011, we had consolidated unamortized prior service cost and net experience losses of approximately $1.7 billion, similar to approximately $1.7 billion at January 2, 2010. Of the total unamortized amounts at January 1, 2011, approximately $1.4 billion was related to asset losses that occurred during 2008, offset by $0.7 billion in asset gains during 2009 and 2010, 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 2010. For 2011, we currently expect total amortization of prior service cost and net experience losses to be approximately $27 million higher than the actual 2010 amount of approximately $113 million. Total employee benefit expense for 2011 is expected to be higher than 2010 due to lower discount rates, a further phase in of the 2008 investment losses, offset by better than expected 2009 and 2010 investment performance. Based on our current actuarial assumptions, we expect 2012 pension expense to increase primarily due to further phase-in of 2008 investment losses.

During 2010 we made contributions in the amount of $350 million to Kellogg’s global tax-qualified pension programs. This amount was mostly discretionary. Additionally we contributed $293 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 losses during each of the next several years would increase versus the 2010 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. The calculation of our income tax provision and deferred income tax assets and liabilities is complex and requires the use of estimates and judgment. Income taxes are provided on the portion of foreign earnings that is expected to be remitted to and taxable in the United States.

We recognize tax benefits associated with uncertain tax positions when, in our judgment, it is more likely than not that the positions will be sustained upon examination by a taxing authority. For tax positions that meet the more likely than not recognition threshold, we initially and subsequently measure the tax benefits as the largest amount that we judge to

 

24


have a greater than 50% likelihood of being realized upon ultimate settlement. Our liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances, such as the progress of tax audits, new or emerging legislation and tax planning. The tax position will be derecognized when it is no longer more likely than not of being sustained. Significant adjustments to our liability for unrecognized tax benefits impacting our effective tax rate are separately presented in the rate reconciliation table of Note 10 within Notes to Consolidated Financial Statements.

 

ACCOUNTING STANDARDS TO BE ADOPTED IN FUTURE PERIODS

In December 2010, the Financial Accounting Standards Board issued a new accounting standard related to application of the goodwill impairment model when a reporting unit has a carrying amount that is zero or a negative value. The new standard clarifies that when this is the case, a goodwill impairment test should be performed if qualitative factors indicate that it is more likely than not that goodwill impairment exists. We will adopt this new accounting standard in the first quarter of 2011. We do not expect the adoption of this standard to have a material effect on our consolidated financial statements.

 

We have taken actions to regain momentum in 2011 through increased innovation and by investing in our brands and our supply chain. We have strong innovations and expect improved trends in our core categories. We expect our internal net sales will grow by 3 to 4 percent. Internal operating profit is expected to be flat to down 2 percent, resulting from the increase in cost pressures as well as a comparison issue related to incentive compensation which was significantly lower in 2010 due to our results. Earnings per share on a currency-neutral basis is expected to grow low single-digits. Gross profit margin is expected to be down slightly for the year. Gross interest expense is expected to be $235 to $245 million. We expect our effective tax rate to be approximately 30%. Lastly, we expect our cash flow performance to remain strong and are currently expecting 2011’s cash flow to be between $1.1 and $1.2 billion.

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 11 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 primarily to third-party purchases, intercompany transactions, and when applicable, nonfunctional currency denominated third-party debt. 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 volatility in the translation of foreign currency denominated 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 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 2010 was $1,075 million, representing a settlement obligation of $20 million. The total notional amount of foreign currency derivative instruments at year-end 2009 was $1,588 million, representing a settlement obligation of $24 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 $108 million at year-end 2010 and $159 million at year-end 2009. These unfavorable changes would generally have been offset by favorable changes in the values of the underlying exposures.

Venezuela was designated as a highly inflationary economy as of the beginning of our 2010 fiscal year.

 

25


Gains and losses resulting from the translation of the financial statements of subsidiaries operating in highly inflationary economies are recorded in earnings. As of the end of our 2009 fiscal year, we used the parallel rate to translate our Venezuelan subsidiary’s financial statements to U.S. dollars. In May 2010, the Venezuelan government effectively eliminated the parallel market. In June 2010, several large Venezuelan commercial banks began operating the Transaction System for Foreign Currency Denominated Securities (SITME). We intend to use SITME to settle U.S. dollar denominated assets and liabilities. Accordingly, we are using the SITME rate at January 1, 2011 to translate our Venezuelan subsidiary’s financial statements to U.S. dollars. During the second quarter of 2010, we recorded an $8 million foreign exchange gain in other income (expense), net, associated with the translation of our subsidiary’s financials into U.S. dollars, with the net impact for full year 2010 amounting to a $3 million gain. On a consolidated basis, Venezuela represents only 1% to 2% of our business; therefore, any ongoing impact is expected to be immaterial.

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 interest rate swaps at year-end 2010 was $1,900 million, representing a settlement receivable of $74 million. The total notional amount of interest rate swaps at year-end 2009 was $1,900 million, representing a settlement receivable of $43 million. Assuming average variable rate debt levels during the year, a one percentage point increase in interest rates would have increased interest expense by approximately $21 million at year-end 2010 and $22 million at year-end 2009.

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 transactions to reduce fluctuations in the price of natural gas used principally in our manufacturing processes. The notional amount of the swaps totaled $125 million as of January 1, 2011 and equates to approximately 50% of our North America manufacturing needs over the remaining hedge period. At year-end January 2, 2010 the notional amount was $146 million.

The total notional amount of commodity derivative instruments at year-end 2010, including the North America natural gas swaps, was $379 million, representing a settlement obligation of approximately $16 million. The total notional amount of commodity derivative instruments at year-end 2009, including the 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 have increased by approximately $36 million at year-end 2010, and $18 million at year-end 2009, 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 1, 2011 or January 2, 2010.

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)    2010        2009        2008  

Net sales

   $ 12,397        $ 12,575        $ 12,822  

Cost of goods sold

     7,108          7,184          7,455  

Selling, general and administrative expense

     3,299          3,390          3,414  

Operating profit

   $ 1,990        $ 2,001        $ 1,953  

Interest expense

     248          295          308  

Other income (expense), net

               (22        (14

Income before income taxes

     1,742          1,684          1,631  

Income taxes

     502          476          485  

Net income

   $ 1,240        $ 1,208        $ 1,146  

Net loss attributable to noncontrolling interests

     (7        (4        (2

Net income attributable to Kellogg Company

   $ 1,247        $ 1,212        $ 1,148  

Per share amounts:

            

Basic

   $ 3.32        $ 3.17        $ 3.01  

Diluted

   $ 3.30        $ 3.16        $ 2.99  

Dividends per share

   $ 1.560        $ 1.430        $ 1.300  

Refer to Notes to Consolidated Financial Statements.

 

27


Kellogg Company and Subsidiaries

Consolidated Balance Sheet

 

(millions, except share data)    2010        2009  

Current assets

       

Cash and cash equivalents

   $ 444        $ 334  

Accounts receivable, net

     1,190          1,093  

Inventories

     1,056          910  

Other current assets

     225          221  

Total current assets

     2,915          2,558  

Property, net

     3,128          3,010  

Goodwill

     3,628          3,643  

Other intangibles, net

     1,456          1,458  

Other assets

     720          531  

Total assets

   $ 11,847        $ 11,200  

Current liabilities

       

Current maturities of long-term debt

   $ 952        $ 1  

Notes payable

     44          44  

Accounts payable

     1,149          1,077  

Other current liabilities

     1,039          1,166  

Total current liabilities

     3,184          2,288  

Long-term debt

     4,908          4,835  

Deferred income taxes

     697          425  

Pension liability

     265          430  

Other liabilities

     639          947  

Commitments and contingencies

       

Equity

       

Common stock, $.25 par value, 1,000,000,000 shares authorized
Issued: 419,272,027 shares in 2010 and 419,058,168 shares in 2009

     105          105  

Capital in excess of par value

     495          472  

Retained earnings

     6,122          5,481  

Treasury stock at cost
53,667,635 shares in 2010 and 37,678,215 shares in 2009

     (2,650        (1,820

Accumulated other comprehensive income (loss)

     (1,914        (1,966

Total Kellogg Company equity

     2,158          2,272  

Noncontrolling interests

     (4        3  

Total equity

     2,154          2,275  

Total liabilities and equity

   $ 11,847        $ 11,200  

Refer to Notes to Consolidated Financial Statements.

 

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Kellogg Company and Subsidiaries

Consolidated Statement of Equity

 

(millions)   Common
stock
    Capital in
excess of
par value
    Retained
earnings
    Treasury stock     Accumulated
other
comprehensive
income (loss)
    Total
Kellogg
Company
equity
   

Non-

controlling
interests

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

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

                (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

                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   
                           

Common stock repurchases

            21        (1,057       (1,057       (1,057  

Net income (loss)

          1,247              1,247        (7     1,240        1,240   

Dividends

          (584           (584       (584  

Other comprehensive income

                52        52          52        52   

Stock compensation

        19                19          19     

Stock options exercised and other

                    4        (22     (5     227                209                209           

Balance, January 1, 2011

    419      $ 105      $ 495      $ 6,122        54      $ (2,650   $ (1,914   $ 2,158      $ (4   $ 2,154      $ 1,292   

Refer to Notes to Consolidated Financial Statements.

 

29


Kellogg Company and Subsidiaries

Consolidated Statement of Cash Flows

 

(millions)    2010        2009        2008  

Operating activities

            

Net income

   $ 1,240        $ 1,208        $ 1,146  

Adjustments to reconcile net income to operating cash flows:

            

Depreciation and amortization

     392          384          375  

Deferred income taxes

     266          (40        157  

Other

     97          13          121  

Pension and other postretirement benefit contributions

     (643        (100        (451

Changes in operating assets and liabilities:

            

Trade receivables

     59          (75        48  

Inventories

     (146        (13        41  

Accounts payable

     72          (59        32  

Accrued income taxes

     (192        112          (85

Accrued interest expense

     9          (5        3  

Accrued and prepaid advertising, promotion and trade allowances

     (12        91          (10

Accrued salaries and wages

     (169        42          (47

All other current assets and liabilities

     35          85          (63

Net cash provided by operating activities

   $ 1,008        $ 1,643        $ 1,267  

Investing activities

            

Additions to properties

   $ (474      $ (377      $ (461

Acquisitions of businesses, net of cash acquired

                         (213

Other

     9          7          (7

Net cash used in investing activities

   $ (465      $ (370      $ (681

Financing activities

            

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

   $ (1      $ (1,284      $ 23  

Issuances of notes payable, with maturities greater than 90 days

               10          190  

Reductions of notes payable, with maturities greater than 90 days

               (70        (316

Issuances of long-term debt

     987          1,241          756  

Reductions of long-term debt

     (1        (482        (468

Net issuances of common stock

     204          131          175  

Common stock repurchases

     (1,052        (187        (650

Cash dividends

     (584        (546        (495

Other

     8          5          5  

Net cash used in financing activities

   $ (439      $ (1,182      $ (780

Effect of exchange rate changes on cash and cash equivalents

     6          (12        (75

Increase (decrease) in cash and cash equivalents

   $ 110        $ 79        $ (269

Cash and cash equivalents at beginning of year

     334          255          524  

Cash and cash equivalents at end of year

   $ 444        $ 334        $ 255  

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 2010 and 2009 fiscal years each contained 52 weeks and ended on January 1, 2011 and January 2, 2010, 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 remaining stated maturities of three months or less when purchased are considered cash equivalents and recorded at cost.

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; office equipment 4-5; computer equipment and capitalized software 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 2010 and 2009, the carrying value of assets held for sale was insignificant.

Goodwill and other intangible assets

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, earnings for companies that are comparable to the Company’s reporting units and discounted cash flow. 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.

Advertising and promotion

The Company expenses production costs of advertising the first time the advertising takes place. Advertising expense is classified in selling, general and administrative (SGA) expense.

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 SGA expense.

Research and development

The costs of research and development (R&D) are expensed as incurred and are classified in 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 in 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 recorded in other financing activities in the Consolidated Statement of Cash Flows. 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 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 in COGS and SGA expense on the Consolidated Statement of Income.

Pension and nonpension postretirement benefits.  Variances between the expected and actual rates of return on plan assets are 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. Management reviews the Company’s

 

32


expected long-term rates of return annually; however, the benefit trust investment performance for one particular year does not, by itself, significantly influence this evaluation. The expected rates of return are not revised provided these rates fall between the 25th and 75th percentile of expected long-term returns, as determined by the Company’s modeling process.

Pension obligation related experience gains or losses are amortized using a straight-line method over the average remaining service period of active plan participants. Health care claims cost related experience gains or losses are recognized in the calculated amount of claims experience over a four year period and once recognized, are amortized using a straight-line method over 15 years.

For defined benefit pension and postretirement plans, the Company records the net overfunded or underfunded position 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.

Postemployment benefits.  The Company recognizes an obligation for postemployment benefit plans that vest or accumulate with service. 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. All gains and losses are recognized over the average remaining service period of active plan participants.

Postemployment benefits that do not vest or accumulate with service or benefits to employees in excess of those specified in the respective plans are expensed as incurred.

Income taxes

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. The current portion of the Company’s unrecognized tax benefits is presented in the Consolidated Balance Sheet in other current assets and other current liabilities, and the amounts expected to be settled after one year are recorded in other assets and other liabilities.

Income taxes are provided on the portion of foreign earnings that is expected to be remitted to and taxable in the United States.

Derivative Instruments

The fair value of derivative instruments is recorded in other current assets, other assets, other current liabilities or other liabilities. Gains and losses representing either hedge ineffectiveness, hedge components excluded from the assessment of effectiveness, or hedges of translational exposure are recorded in the Consolidated Statement of Income in other income (expense), net. In the Consolidated Statement of Cash Flows, settlements of cash flow and fair value hedges are classified as an operating activity; settlements of all other derivatives are classified as a financing activity.

Cash flow hedges.  Qualifying derivatives are accounted for as cash flow hedges when the hedged item is a forecasted transaction. Gains and losses on these instruments are recorded in other comprehensive income until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive income (loss) (AOCI) to the Consolidated Statement of Income on the same line item as the underlying transaction.

Fair value hedges.  Qualifying derivatives are accounted for as fair value hedges when the hedged item is a recognized asset, liability, or firm commitment. Gains and losses on these instruments are recorded in earnings, offsetting gains and losses on the hedged item.

Net investment hedges.  Qualifying derivative and nonderivative financial instruments are accounted for as net investment hedges when the hedged item is a nonfunctional currency investment in a subsidiary. Gains and losses on these instruments are included in foreign currency translation adjustments in AOCI.

Other contracts.  The Company also periodically enters into foreign currency forward contracts and options to reduce volatility in the translation of foreign currency earnings to U.S. dollars. Gains and losses on these instruments are recorded in other income (expense), net, generally reducing the exposure to translation volatility during a full-year period.

Foreign currency exchange risk.  The Company is exposed to fluctuations in foreign currency cash flows related primarily to third-party purchases, intercompany transactions and when applicable, nonfunctional currency denominated third-party debt. The 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, the Company is exposed to volatility in the translation of foreign currency denominated earnings to U.S. dollars. Management assesses foreign currency risk based on transactional cash flows and translational volatility and may enter into forward contracts, options, and currency swaps to

 

33


reduce fluctuations in 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 issues.

For foreign currency cash flow and fair value hedges, the assessment of effectiveness is generally based on changes in spot rates. Changes in time value are reported in other income (expense), net.

Interest rate risk.  The Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt. The Company periodically uses interest rate swaps, including forward-starting swaps, 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.

Fixed-to-variable interest rate swaps are accounted for as fair value hedges and the assessment of effectiveness is based on changes in the fair value of the underlying debt, using incremental borrowing rates currently available on loans with similar terms and maturities.

Price risk.  The Company is exposed to price fluctuations primarily as a result of anticipated purchases of raw and packaging materials, fuel, and energy. The Company has 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.

Commodity contracts are accounted for as cash flow hedges. The assessment of effectiveness for exchange-traded instruments is based on changes in futures prices. The assessment of effectiveness for over-the-counter transactions is based on changes in designated indices.

New accounting standards

Business combinations and noncontrolling interests.  In December 2007, the FASB (Financial Accounting Standards Board) 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. The impact of adoption of this standard on the Company’s financial statements was not 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 impact of adoption of this standard on the Company’s financial statements was not significant.

Variable interest entities.  In December 2009, the FASB amended the Accounting Standards Codification related to the consolidation provisions that apply to variable interest entities. This guidance was effective for fiscal years beginning after November 15, 2009 and was adopted by the Company on a prospective basis as of January 3, 2010 without material impact to its consolidated financial statements.

NOTE 2

ACQUISITIONS, GOODWILL AND OTHER INTANGIBLE ASSETS

Acquisitions

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

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 results of operations when considered individually or in the aggregate.

 

34


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. This acquisition is 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 cash in connection with the transaction, including approximately $8 million to the seller’s lenders to settle debt of the acquired entity. This acquisition is 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 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 $31 million cash 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. Additional purchase price payable in June 2011 amounts to $5 million and is recorded on the Company’s Consolidated Balance Sheet in other current liabilities. This acquisition is included in the Asia Pacific operating segment.

In conjunction with acquisition of Navigable Foods, the Company obtained the option to purchase the noncontrolling interest of Navigable Foods 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, a leading producer of cereal, cookie, and cracker products in Russia. United Bakers had 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 prior to 2008 for transaction fees and advances. This acquisition is included in the Europe operating segment.

The purchase agreement between the Company and the seller provided for payment of contingent consideration under a calculation based primarily on sales, capital expenditures and earnings before income taxes, depreciation and amortization for the three-year period ended December 31, 2010. Based on the calculation, the Company is not required to provide contingent consideration to the seller.

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)    2010      2009      2010      2009  

Trademarks

   $ 19      $ 19      $ 16      $ 15  

Other

     41        41        31        30  

Total

   $ 60      $ 60      $ 47      $ 45  

 

      2010      2009  

Amortization expense (a)

   $ 2      $ 3  

 

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

 

Intangible assets not subject to amortization  
      Total carrying
amount
 
(millions)    2010      2009  

Trademarks

   $ 1,443      $ 1,443  

 

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

January 3, 2009

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

Currency translation adjustment

           1              5       6  

January 2, 2010

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

Impairment charge

                         (20     (20

Currency translation adjustment

                         5       5  

January 1, 2011

  $ 3,539     $ 62     $      $ 27     $ 3,628  

 

(a) Includes Australia, Asia and South America.

Impairment charges

In the fourth quarter of 2010, the Company recorded impairment charges totaling $29 million in connection

 

35


with the Navigable Foods business in China, which was purchased by the Company in 2008.

The charges included $20 million representing the goodwill recorded in conjunction with the 2008 acquisition. The China business has been generating operating losses since the acquisition and that trend is expected to continue. As a result, management determined in the fourth quarter of 2010 that the current business has not proven to be the right vehicle for entry into the Chinese marketplace and began exploring various strategic alternatives to reduce operating losses in the future. The impairment charge was recorded in SGA expense in the Asia Pacific operating segment.

Prior to assessing the goodwill for impairment, the Company determined that the long-lived assets of the China reporting unit were impaired and should be written down to their estimated fair value of $10 million. This resulted in a fixed asset impairment charge of $9 million in 2010 that was recorded in the Asia Pacific operating segment, of which $8 million was recorded in COGS, and $1 million was recorded in SGA expense.

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 2010, the Company recorded $19 million of costs associated with exit or disposal activities. $6 million represented severance, $5 million was for pension costs, $7 million for other costs including relocation of assets and employees and $1 million for asset write-offs. $4 million of the charges were recorded in cost of goods sold (COGS) in the Europe operating segment. $15 million of the charges were recorded in selling, general and administrative (SGA) expense in the following operating segments (in millions): North America—$11; Europe—$2; and Asia Pacific—$2.

The Company recorded $65 million of costs in 2009 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.

For 2008, the Company recorded charges of $27 million, comprised of $7 million of asset write- offs, $17 million for 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.

At January 1, 2011, exit cost reserves were $5 million, related to severance payments which will be made in 2011. Exit cost reserves at January 2, 2010 were $25 million related to severance payments.

Specific initiatives

2010 activities

During 2010, the Company incurred costs related to two ongoing programs which will result in COGS and SGA expense savings. The COGS program relates to Kellogg’s lean, efficient, and agile network (K LEAN). The SGA programs focus on the efficiency and effectiveness of various support functions.

The Company commenced K LEAN in 2009. K LEAN seeks to optimize the Company’s global manufacturing network, reduce waste, and develop best practices on a global basis. The Company incurred $4 million of costs in the Europe operating segment for 2010 which included cash payments for severance and other cash costs for asset removal and relocation at various global manufacturing facilities.

The following table presents the total program costs through January 1, 2011.

 

(millions)   Employee
severance
    Other
cash
costs
(a)
    Asset
write-offs
    Retirement
benefits
(b)
    Total  

For the year ended, January 2, 2010

  $ 15     $ 6     $      $ 3     $ 24  

For the year ended, January 1, 2011

    3              1              4  

Total program costs

  $ 18     $ 6     $ 1     $ 3     $ 28  

 

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

 

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

The above costs impacted operating segments, as follows (in millions): North America—$14; Europe—$13; and Asia Pacific—$1. The cost and cash outlay in 2011 for these programs is estimated to be an additional $3 million.

 

36


The following table presents a reconciliation of the severance reserve for this program.

 

(millions)   Beginning
of period
    Accruals     Payments     End of
period
 

For the year ended, January 2, 2010

  $      $ 15      $ (9   $ 6   

For the year ended, January 1, 2011

    6        3        (7     2   

Total project to date

          $ 18      $ (16        

In 2009, the Company commenced various 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 incurred $15 million of costs for 2010 which included 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—$11; Europe—$2; and Asia Pacific—$2.

The following table presents the total program costs through January 1, 2011.

 

(millions)   Employee
severance
    Other cash
costs (a)
    Retirement
benefits (b)
    Total  

For the year ended, January 2, 2010

  $ 17      $ 8      $      $ 25   

For the year ended, January 1, 2011

    3        7        5        15   

Total program costs

  $ 20      $ 15      $ 5      $ 40   

 

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

 

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

The above costs impacted operating segments, as follows (in millions): North America—$21; Europe—$15; Latin America—$1; and Asia Pacific—$3. The cost and cash outlay for these programs in 2011 is estimated to be an additional $10 million.

The following table presents a reconciliation of the severance reserve for this program.

 

(millions)   Beginning
of period
    Accruals     Payments     End of
period
 

For the year ended, January 2, 2010

  $      $ 17     $ (5   $ 12  

For the year ended, January 1, 2011