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Kellogg Company 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

 

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

For the quarterly period ended July 2, 2011

OR

 

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

For the transition period from                  to                 

Commission file number 1-4171

KELLOGG COMPANY

 

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

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

Registrant’s telephone number: 269-961-2000

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

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

Yes  x    No  ¨

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

 

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

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

Yes  ¨    No  x

Common Stock outstanding as of July 30, 2011 — 362,003,351 shares

 

 

 


Table of Contents

KELLOGG COMPANY

INDEX

 

     Page  

PART I — Financial Information

  

Item 1:

  

Financial Statements

  

Consolidated Balance Sheet — July 2, 2011 and January 1, 2011

     3   

Consolidated Statement of Income — quarter and year-to-date periods ended July 2, 2011 and July  3, 2010

     4   

Consolidated Statement of Equity — year ended January 1, 2011 and year-to-date period ended July  2, 2011

     5   

Consolidated Statement of Cash Flows — year-to-date periods ended July 2, 2011 and July 3, 2010

     6   

Notes to Consolidated Financial Statements

     7   

Item 2:

  

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

     23   

Item 3:

  

Quantitative and Qualitative Disclosures about Market Risk

     32   

Item 4:

  

Controls and Procedures

     32   

PART II — Other Information

  

Item 1A:

  

Risk Factors

     33   

Item 2:

  

Unregistered Sales of Equity Securities and Use of Proceeds

     33   

Item 6:

  

Exhibits

     33   

Signatures

     34   

Exhibit Index

     35   

 

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Table of Contents

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED BALANCE SHEET

(millions, except per share data)

 

     

July 2,
2011

(unaudited)

   

January 1,
2011

*

 

Current assets

    

Cash and cash equivalents

   $ 457     $ 444  

Accounts receivable, net

     1,364       1,190  

Inventories:

    

Raw materials and supplies

     239       224  

Finished goods and materials in process

     778       832  

Deferred income taxes

     161       110  

Other prepaid assets

     137       115  

Total current assets

     3,136       2,915  

Property, net of accumulated depreciation of $4,908 and $4,690

     3,246       3,128  

Goodwill

     3,632       3,628  

Other intangibles, net of accumulated amortization of $48 and $47

     1,455       1,456  

Pension

     474       333  

Other assets

     413       387  

Total assets

   $ 12,356     $ 11,847  
                  

Current liabilities

    

Current maturities of long-term debt

   $      $ 952  

Notes payable

     734       44  

Accounts payable

     1,208       1,149  

Accrued advertising and promotion

     436       405  

Accrued income taxes

     31       60  

Accrued salaries and wages

     205       153  

Other current liabilities

     412       421  

Total current liabilities

     3,026       3,184  

Long-term debt

     5,308       4,908  

Deferred income taxes

     768       697  

Pension liability

     171       265  

Nonpension postretirement benefits

     199       214  

Other liabilities

     416       425  

Commitments and contingencies

    

Equity

    

Common stock, $.25 par value

     105       105  

Capital in excess of par value

     513       495  

Retained earnings

     6,511       6,122  

Treasury stock, at cost

     (2,890     (2,650

Accumulated other comprehensive income (loss)

     (1,765     (1,914

Total Kellogg Company equity

     2,474       2,158  

Noncontrolling interests

     (6     (4

Total equity

     2,468       2,154  

Total liabilities and equity

   $ 12,356     $ 11,847  
                  

 

* Condensed from audited financial statements.

Refer to Notes to Consolidated Financial Statements.

 

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Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME

(millions, except per share data)

 

     Quarter ended     Year-to-date period ended  
(Results are unaudited)    July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 

Net sales

   $ 3,386     $ 3,062       $6,871       $6,380  

Cost of goods sold

     1,943       1,757       4,007       3,650  

Selling, general and administrative expense

     900       822       1,749       1,610  

Operating profit

     543       483       1,115       1,120  

Interest expense

     53       61       120       126  

Other income (expense), net

     (1     7       (1     8  

Income before income taxes

     489       429       994       1,002  

Income taxes

     147       128       287       284  

Net income

   $ 342     $ 301       $   707       $   718  

Net income (loss) attributable to noncontrolling interests

     (1     (1     (2     (2

Net income attributable to Kellogg Company

   $ 343     $ 302       $   709       $   720  

Per share amounts:

        

Basic

   $ 0.94     $ 0.80       $  1.95       $  1.89  

Diluted

   $ 0.94     $ 0.79       $  1.93       $  1.88  

Dividends per share

   $ 0.405     $ 0.375       $0.810       $0.750  

Average shares outstanding:

        

Basic

     363       381       364       380  

Diluted

     366       384       367       384  

Actual shares outstanding at period end

                     362       378  
                                  

Refer to Notes to Consolidated Financial Statements.

 

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Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF EQUITY

(millions)

 

    Common
stock
 

Capital in

excess of

par value

   

Retained

    Treasury stock    

Accumulated

other

comprehensive

   

Total Kellogg
Company

   

Non-

controlling

   

Total

   

Total

comprehensive

 
(unaudited)   shares   amount     earnings     shares     amount       income (loss)     equity     interests       equity       income (loss)  

Balance, January 2, 2010

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

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  

Common stock repurchases

          9     (513)          (513       (513  

Net income (loss)

          709             709       (2)        707       707  

Dividends

          (296           (296       (296  

Other comprehensive income

                149       149         149       149  

Stock compensation

        11               11         11    

Stock options exercised and other

        7       (24   (5)     273          256         256    
                                                                             

Balance, July 2, 2011

  419   $105   $ 513       $6,511     58     $(2,890)      $ (1,765     $  2,474     $ (6)      $ 2,468     $ 856  
                                                                             

Refer to Notes to Consolidated Financial Statements.

 

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Table of Contents

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS

(millions)

 

     Year-to-date period ended  
(unaudited)    July 2,
2011
    July 3,
2010
 

Operating activities

    

Net income

     $ 707       $ 718  

Adjustments to reconcile net income to operating cash flows:

    

Depreciation and amortization

     175       178  

Deferred income taxes

     (1     (52

Other

     25       73  

Postretirement benefit plan contributions

     (183     (36

Changes in operating assets and liabilities:

    

Trade receivables

     (285     (84

Inventories

     39       25  

Accounts payable

     59       (1

Accrued income taxes

     122       (22

Accrued interest expense

     (18     (1

Accrued and prepaid advertising, promotion and trade allowances

     6       (31

Accrued salaries and wages

     51       (135

All other current assets and liabilities

     (51     (39

Net cash provided by operating activities

     646       593  

Investing activities

    

Additions to properties

     (243     (147

Other

     5       2  

Net cash used in investing activities

     (238     (145

Financing activities

    

Net issuances of notes payable

     687       110  

Issuances of long-term debt

     397         

Reductions of long-term debt

     (946     (1

Net issuances of common stock

     249       148  

Common stock repurchases

     (518     (266

Cash dividends

     (296     (286

Other

     10       6  

Net cash used in financing activities

     (417     (289

Effect of exchange rate changes on cash and cash equivalents

     22       (22

Increase in cash and cash equivalents

     13       137  

Cash and cash equivalents at beginning of period

     444       334  

Cash and cash equivalents at end of period

     $ 457       $ 471  
                  

Refer to Notes to Consolidated Financial Statements.

 

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Table of Contents

Notes to Consolidated Financial Statements

for the quarter ended July 2, 2011 (unaudited)

Note 1 Accounting Policies

Basis of presentation

The unaudited interim financial information of Kellogg Company (the Company) included in this report reflects normal recurring adjustments that management believes are necessary for a fair statement of the results of operations, financial position, equity and cash flows for the periods presented. This interim information should be read in conjunction with the financial statements and accompanying notes contained on pages 27 to 57 of the Company’s 2010 Annual Report on Form 10-K.

The condensed balance sheet data at January 1, 2011 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the quarterly period ended July 2, 2011 are not necessarily indicative of the results to be expected for other interim periods or the full year.

Accounting standards to be adopted in future periods

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2011-05, “Presentation of Comprehensive Income,” requiring most entities to present items of net income and other comprehensive income either in one continuous statement — referred to as the statement of comprehensive income — or in two separate, but consecutive, statements of net income and other comprehensive income. The update does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU No. 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and should be applied retrospectively. Early adoption is permitted. The Company will be adopting ASU 2011-05 at the beginning of its 2012 fiscal year.

Note 2 Goodwill and other intangible assets

Changes in the carrying amount of goodwill for the quarter ended July 2, 2011 are presented in the following table.

Carrying amount of goodwill

 

(millions)    North America      Europe      Latin America      Asia Pacific (a)      Consolidated  

January 1, 2011

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

Currency translation adjustment

     —             3                1        4  

July 2, 2011

     $3,539            $65        $—         $28        $3,632  
                                              

(a) Includes Australia, Asia and South Africa.

Intangible assets subject to amortization

 

     Gross carrying amount    Accumulated amortization
(millions)    July 2,
2011
   January 1,
2011
   July 2,
2011
   January 1,
2011

Trademarks

   $19    $19    $17    $16

Other

     41      41      31      31

Total

   $60    $60    $48    $47
                     

For intangible assets in the preceding table, amortization was less than $1 million for each of the current and prior year comparable quarters. The currently estimated aggregate annual amortization expense for full-year 2011 and each of the four succeeding fiscal years is approximately $2 million.

Intangible assets not subject to amortization

 

     Total carrying amount  
(millions)    July 2,
2011
     January 1,
2011
 

Trademarks

   $ 1,443      $ 1,443  
                   

 

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Note 3 Exit or disposal activities

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

2011 activities

During 2011, the Company incurred exit costs related to two ongoing programs which will result in cost of goods sold (COGS) and selling, general and administrative (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.

Total charges incurred during the quarter and year-to-date periods ended July 2, 2011 and July 3, 2010 were as follows:

 

     Quarter ended, July 2, 2011      Quarter ended, July 3, 2010  
(millions)    COGS
program
     SGA
programs
     Total      COGS
program
     SGA
programs
     Total  

Other cash costs (a)

     $—            $—          $—          $—          $1         $1   

Retirement benefits (b)

     —                                 —           

Total

     $—            $  6         $  6         $  1         $1         $2   
                                                       

 

(a) Includes cash costs for equipment removal and relocation.
(b) Pension plan curtailment losses and special termination benefits.

 

     Year-to-date period ended,
July 2, 2011
     Year-to-date period ended,
July 3, 2010
 
(millions)    COGS
program
     SGA
programs
     Total      COGS
program
     SGA
programs
     Total  

Employee severance

     $4          $—           $  4         $  2         $  1         $  3   

Other cash costs (a)

     —           —           —          —                  

Asset write-offs

     1          —                  —          —          —    

Retirement benefits (b)

     —           6                        —           

Total

     $5          $  6          $11         $  3         $  6         $  9   
                                                       

 

(a) Includes cash costs for equipment removal and relocation.
(b) Pension plan curtailment losses and special termination benefits.

Total program costs incurred through July 2, 2011 were as follows:

 

     Total program costs through
July 2, 2011
 
(millions)    COGS
program
     SGA
programs
     Total  

Employee severance

     $22          $20         $42    

Other cash costs (a)

     6          15         21    

Asset write-offs

     2          —           2    

Retirement benefits (b)

     3          11         14    

Total

     $33          $46         $79    
                            
                            

 

(a) Includes cash costs for equipment removal and relocation.
(b) Pension plan curtailment losses and special termination benefits.

In 2009, the Company commenced K LEAN. Refer to page 36 of the Company’s 2010 Annual Report on Form 10-K for further information on this initiative. Costs for this program impacted the following operating segments during the quarter and year-to-date periods ended July 2, 2011 and July 3, 2010.

 

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     COGS program  
     Quarter ended      Year-to-date period ended  
(millions)    July 2, 2011      July 3, 2010      July 2, 2011      July 03, 2010  

North America

     $—         $—         $—         $1  

Europe

             1        5        2  

Total

     $—         $  1        $  5        $3  
                                     

These costs represent employee severance and other cash costs associated with the elimination of hourly and salaried positions, as well as non-cash asset write offs at various global manufacturing facilities. To date, we have incurred $33 million in total exit costs for this program. The costs have impacted our operating segments, as follows (in millions): North America-$14; Europe-$18; and Asia Pacific-$1. Based on forecasted exchange rates, the Company currently expects to incur an additional $10 million in exit costs for this program during 2011.

In 2009, the Company commenced various SGA programs which resulted in an improvement in the efficiency and effectiveness of various support functions. Refer to page 37 of the Company’s 2010 Annual Report on Form 10-K for further information on these initiatives. Costs for these programs impacted the following operating segments during the quarter and year-to-date periods ended July 2, 2011 and July 3, 2010 as follows:

 

     SGA programs
     Quarter ended    Year-to-date period ended
(millions)    July 2, 2011    July 3, 2010    July 2, 2011    July 3, 2010

North America

   $6    $1    $6    $4

Europe

      (1)      

Asia Pacific (a)

      1       2

Total

   $6    $1    $6    $6
                     

 

(a) Includes Australia, Asia and South Africa.

These costs represent severance and other cash costs associated with the elimination of positions. To date, we have incurred $46 million in exit costs for these programs. The costs have impacted our operating segments as follows (in millions): North America-$27; Europe-$15; Asia Pacific-$3; and Latin America-$1. Based on forecasted exchange rates, the Company currently expects to incur an additional $10 million in exit costs for these programs during 2011.

Reserves for the COGS and SGA programs are primarily for employee severance and will be paid out by the end of 2011. The detail is as follows:

 

(millions)    Balance
January 1, 2011
   Accruals    Payments   Balance
July 2, 2011

COGS program

   $2    $4    $(5)   $1

SGA programs

     3         (2)     1

Total

   $5    $4    $(7)   $2
                    

Note 4 Equity

Earnings per share

Basic earnings per share is determined by dividing net income attributable to Kellogg Company by the weighted average number of common shares outstanding during the period. Diluted earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares consist principally of employee stock options issued by the Company, and to a lesser extent, certain contingently issuable performance shares. Basic earnings per share is reconciled to diluted earnings per share in the following table. The total number of anti-dilutive potential common shares excluded from the reconciliation were 5 million and 8 million for the quarter and year-to-date periods ended July 2, 2011, respectively, and 4 million for both the quarter and year-to-date periods ended July 3, 2010.

 

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Quarters ended July 2, 2011 and July 3, 2010:

 

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

2011

              

Basic

       $343          363          $0.94  

Dilutive potential common shares

                  3           

Diluted

       $343          366          $0.94  

2010

              

Basic

       $302          381          $0.80  

Dilutive potential common shares

                  3          (0.01 )

Diluted

       $302          384          $0.79  
                                  

Year-to-date period ended July 2, 2011 and July 3, 2010:

 

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

2011

              

Basic

       $709          364          $1.95  

Dilutive potential common shares

                  3          (0.02 )

Diluted

       $709          367          $1.93  

2010

              

Basic

       $720          380          $1.89  

Dilutive potential common shares

                  4          (0.01 )

Diluted

       $720          384          $1.88  
                                  

During the year-to-date period ended July 2, 2011, the Company issued 0.4 million shares to employees and directors under various benefit plans and stock purchase programs. Equity-based compensation is discussed further in Note 6.

On April 23, 2010, the Company’s board of directors authorized a $2.5 billion three-year share repurchase program for 2010 through 2012. During the year-to-date period ended July 2, 2011, the Company repurchased 9 million shares of common stock for a total of $513 million. During the year-to-date period ended July 3, 2010, the Company repurchased 7 million shares of common stock for a total of $356 million, of which $266 million was paid during the six-month period and $90 million was payable at July 3, 2010 for stock repurchases that did not settle prior to the end of the reporting period.

Comprehensive income

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

During the first quarter of 2010, the Company amended its U.S. postretirement healthcare benefit plan, which resulted in a $17 million decrease of a deferred tax asset.

 

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Quarter ended July 2, 2011:

 

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

2011

        

Net income

           $342     

Other comprehensive income:

        

Foreign currency translation adjustments

     $  34          $ —           34     

Cash flow hedges:

        

Unrealized gain (loss) on cash flow hedges

     (46)          16           (30)     

Reclassification to net earnings

     (3)          1           (2)     

Postretirement and postemployment benefits:

        

Amounts arising during the period:

        

Net experience gain (loss)

     (1)          —           (1)     

Reclassification to net earnings:

        

Net experience loss

     32          (11)           21     

Prior service cost

     3            (1)           2     
       $  19          $    5           24     

Total comprehensive income

                       $366     
                            
Quarter ended July 3, 2010:         
(millions)    Pre-tax
amount
     Tax (expense)
or benefit
     After-tax
amount
 

2010

        

Net income

           $ 301   

Other comprehensive income:

        

Foreign currency translation adjustments

     $(112)          $—            (112)   

Cash flow hedges:

        

Unrealized gain (loss) on cash flow hedges

     (4)          —            (4)   

Reclassification to net earnings

     18          (5)          13   

Postretirement and postemployment benefits:

        

Amounts arising during the period:

        

Net experience gain (loss)

     (3)          1          (2)   

Prior service credit (cost)

     1          —             

Reclassification to net earnings:

        

Net experience loss

     26          (8)          18   

Prior service cost

     2          (1)           
       $  (72)          $(13)          (85)   

Total comprehensive income

                       $ 216   
                            

 

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Table of Contents

Year-to-date period ended July 2, 2011:

 

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

2011

        

Net income

           $707   

Other comprehensive income:

        

Foreign currency translation adjustments

     $143         $—           143   

Cash flow hedges:

        

Unrealized gain (loss) on cash flow hedges

     (35)         12          (23)   

Reclassification to net earnings

     (11)         4          (7)   

Postretirement and postemployment benefits:

        

Amounts arising during the period:

        

Net experience gain (loss)

     (13)         4          (9)   

Prior service credit (cost)

     (1)         —           (1)   

Reclassification to net earnings:

        

Net experience loss

     64         (22)          42   

Prior service cost

            (2)           
       $153         $  (4)          149   

Total comprehensive income

                       $856   
                            

Year-to-date period ended July 3, 2010:

 

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

2010

        

Net income

           $718   

Other comprehensive income:

        

Foreign currency translation adjustments

     $(158)         $—           (158)   

Cash flow hedges:

        

Unrealized gain (loss) on cash flow hedges

     (39)         11          (28)   

Reclassification to net earnings

     31         (9)          22   

Postretirement and postemployment benefits:

        

Amounts arising during the period:

        

Net experience gain (loss)

     15         (5)          10   

Prior service credit (cost)

            (17)          (15)   

Reclassification to net earnings:

        

Net experience loss

     51         (16)          35   

Prior service cost

            (2)           
       $  (92)         $(38)          (130)   

Total comprehensive income

                       $588   
                            

Accumulated other comprehensive income (loss) as of July 2, 2011 and January 1, 2011 consisted of the following:

 

(millions)    July 2,
2011
     January 1,
2011
 

Foreign currency translation adjustments

     $   (646)         $   (789)   

Cash flow hedges — unrealized net loss

     (5)         25   

Postretirement and postemployment benefits:

     

Net experience loss

     (1,042)         (1,075)   

Prior service cost

     (72)         (75)   

Total accumulated other comprehensive income (loss)

     $(1,765)         $(1,914)   
                   

 

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Table of Contents

Note 5 Debt

The following table presents the components of notes payable at July 2, 2011 and January 1, 2011:

 

(millions)    July 2, 2011      January 1, 2011  
      Principal
amount
     Effective
interest rate
     Principal
amount
     Effective
interest rate
 

U.S. commercial paper

     $675        0.25%         $—         —%   

Bank borrowings

     59                 44           

Total

     $734                 $44           
                                     

In May 2011, the Company issued $400 million of seven-year 3.25% fixed rate U.S. Dollar Notes, using the proceeds from these Notes for general corporate purposes including repayment of commercial paper. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions, as well as a change of control provision.

During the first quarter of 2011, the Company repaid its $946 million, ten-year 6.6% U.S. Dollar Notes at maturity with U.S. commercial paper.

In March 2011, the Company entered into an unsecured Four-Year Credit Agreement to replace its existing unsecured Five-Year Credit Agreement, which would have expired in November 2011. The Four-Year Credit Agreement allows the Company to borrow, on a revolving credit basis, up to $2.0 billion, to obtain letters of credit in an aggregate amount up to $75 million, U.S. swingline loans in an aggregate amount up to $200 million and European swingline loans in an aggregate amount up to $400 million and to provide a procedure for lenders to bid on short-term debt of the Company. The agreement contains customary covenants and warranties, including specified restrictions on indebtedness, liens, sale and leaseback transactions, and a specified interest coverage ratio. If an event of default occurs, then, to the extent permitted, the administrative agent may terminate the commitments under the credit facility, accelerate any outstanding loans under the agreement, and demand the deposit of cash collateral equal to the lender’s letter of credit exposure plus interest.

 

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Table of Contents

Note 6 Stock compensation

The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, and to a lesser extent, executive performance shares and restricted stock grants. Additionally, the Company awards restricted stock to its non-employee directors. The interim information below should be read in conjunction with the disclosures included on pages 41 to 44 of the Company’s 2010 Annual Report on Form 10-K.

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

 

     Quarter ended    Year-to-date period ended
(millions)    July 2, 2011    July 3, 2010    July 2, 2011    July 3, 2010

Pre-tax compensation expense

   $12    $10    $22    $23
                     

Related income tax benefit

   $  4    $  3    $  8    $  8
                     

As of July 2, 2011, total stock-based compensation cost related to non-vested awards not yet recognized was $63 million and the weighted-average period over which this amount is expected to be recognized was 2 years.

Stock options

During the year-to-date periods ended July 2, 2011 and July 3, 2010, the Company granted non-qualified stock options to eligible employees as presented in the following activity tables. Terms of these grants and the Company’s methods for determining grant-date fair value of the awards were consistent with that described on pages 42 and 43 of the Company’s 2010 Annual Report on Form 10-K.

Year-to-date period ended July 2, 2011:

 

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

Outstanding, beginning of period

       26        $47         

Granted

       5        53         

Exercised

          (6)        45         

Forfeitures and expirations

     —         —          
                                    

Outstanding, end of period

     25        $48         6.7        $177  
                                    

Exercisable, end of period

     16        $46         5.5        $146  
                                    
Year-to-date period ended July 3, 2010:   
Employee and director stock options    Shares
(millions)
    Weighted-
average
exercise
price
     Weighted-
average
remaining
contractual
term (yrs.)
     Aggregate
intrinsic
value
(millions)
 

Outstanding, beginning of period

     26       $45        

Granted

     4       53        

Exercised

     (3     44        

Forfeitures and expirations

                    
                                    

Outstanding, end of period

     27       $46        6.7        $132  
                                    

Exercisable, end of period

     21       $46        5.9        $107  
                                    

 

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The weighted-average fair value of options granted was $7.59 per share for the year-to-date period ended July 2, 2011 and $7.90 per share for the year-to-date period ended July 3, 2010. The fair value was estimated using the following assumptions:

 

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

Grants within the year-to-date period ended July 2, 2011:

   17%   6.98    3.07%   3.10%

Grants within the year-to-date period ended July 3, 2010:

   20%   4.94    2.54%   2.80%
                   

The total intrinsic value of options exercised was $56 million for the year-to-date period ended July 2, 2011 and $33 million for the year-to-date period ended July 3, 2010.

Performance shares

In the first quarter of 2011, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year operating profit and internal net sales growth targets are achieved.

The 2011 target grant currently corresponds to approximately 225,000 shares, with a grant-date fair value of $48 per share. The actual number of shares issued on the vesting date could range from 0 to 200% of target, depending on actual performance achieved. Based on the market price of the Company’s common stock at July 2, 2011, the maximum future value that could be awarded to employees on the vesting date for all outstanding performance share awards was as follows:

 

(millions)    July 2, 2011

2009 Award

   $19

2010 Award

   $22

2011 Award

   $25

The 2008 performance share award, payable in stock, was settled at 69% of target in February 2011 for a total dollar equivalent of $6 million.

Note 7 Employee benefits

The Company sponsors a number of U.S. and foreign pension, other nonpension postretirement and postemployment plans to provide various benefits for its employees. These plans are described on pages 44 to 49 of the Company’s 2010 Annual Report on Form 10-K. Components of Company plan benefit expense for the periods presented are included in the tables below.

 

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Table of Contents
Pension   
     Quarter ended      Year-to-date period ended  
(millions)    July 2, 2011      July 3, 2010      July 2, 2011      July 3, 2010  

Service cost

     $ 23          $ 21          $   49          $   44    

Interest cost

     53          49          105          99    

Expected return on plan assets

     (94)          (77)          (186)          (156)    

Amortization of unrecognized prior service cost

     3          3          7          7    

Recognized net loss

     26          20          52          40    

Settlement cost

     3          —           4          —     
                                     

Total pension expense

     $ 14          $ 16          $   31          $   34    
                                     
Other nonpension postretirement   
     Quarter ended      Year-to-date period ended  
(millions)    July 2, 2011      July 3, 2010      July 2, 2011      July 3, 2010  

Service cost

     $   5          $   5          $ 11          $ 10   

Interest cost

     15          16          31          32   

Expected return on plan assets

     (22)          (16)          (44)          (32)   

Amortization of unrecognized prior service cost

     —           (1)          (1)          (1)   

Recognized net loss

     5          5          10           
                                     

Total postretirement benefit expense

     $   3          $   9          $   7          $ 18   
                                     
Postemployment   
     Quarter ended      Year-to-date period ended  
(millions)    July 2, 2011      July 3, 2010      July 2, 2011      July 3, 2010  

Service cost

     $1        $1        $3        $3  

Interest cost

       1          1          2          2  

Recognized net loss

       1          1          2          2  
                                     

Total postemployment benefit expense

     $3        $3        $7        $7  
                                     
Company contributions to employee benefit plans are summarized as follows:   
(millions)            Pension      Nonpension
postretirement
     Total  

Quarter ended:

           

July 2, 2011

        $    1        $    4        $    5  

July 3, 2010

              $  10        $    4        $  14  

Year-to-date period ended:

           

July 2, 2011

        $175        $    8        $183  

July 3, 2010

              $  29        $    7        $  36  

Full year:

           

Fiscal year 2011 (projected)

        $180        $  20        $200  

Fiscal year 2010 (actual)

              $350        $293        $643  

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

Note 8 Income taxes

The consolidated effective tax rate for the quarter ended July 2, 2011, of 30% was comparable to prior year’s rate of 30%. The consolidated effective tax rate for the year-to-date period ended July 2, 2011 was 29%, compared to the prior year-to-date period ended July 3, 2010 rate of 28%. Both year-to-date periods were positively impacted by discrete items. The effective rate for 2011 benefited from a first quarter international legal restructuring as well as the closing of various audits, while the effective rate for 2010 benefited from an immaterial correction of an item related to prior years.

As of July 2, 2011, the Company classified $12 million of unrecognized tax positions as a net current liability, representing several income tax positions under examination in various jurisdictions. Management’s estimate of reasonably possible changes in unrecognized tax benefits during the next twelve months consists of the current liability balance, expected to be settled within one year, offset by $9 million of projected additions. Management is currently unaware of any issues under review that could result in significant additional payments, accruals or other material deviation in this estimate.

 

16


Table of Contents

Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the year-to-date period ended July 2, 2011; $50 million of this total represents the amount that, if recognized, would affect the Company’s effective income tax rate in future periods.

 

(millions)        

January 1, 2011

   $ 104  

Tax positions related to current year:

  

Additions

     5  

Tax positions related to prior years:

  

Additions

     4  

Reductions

     (14

Settlements

     (29

July 2, 2011

   $ 70  
          

The Company had the following amounts of income tax related interest accrued as of January 1, 2011 and July 2, 2011.

 

(millions)        

Interest accrued at January 1, 2011

   $ 26  

Reduction of interest expense recognized for the year-to-date period ended July 2, 2011

   $ (4

Interest accrued at July 2, 2011

   $ 16  

Note 9 Derivative instruments and fair value measurements

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

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

Total notional amounts of the Company’s derivative instruments as of July 2, 2011 and January 1, 2011 were as follows:

 

(millions)    July 2,
2011
     January 1,
2011
 

Foreign currency exchange contracts

     $1,278        $1,075  

Interest rate contracts

     2,700        1,900  

Commodity contracts

     291        379  

Total

     $4,269        $3,354  
                   

Following is a description of each category in the fair value hierarchy and the financial assets and liabilities of the Company that were included in each category at July 2, 2011 and January 1, 2011, measured on a recurring basis.

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

Level 2 – Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability.

For the Company, level 2 financial assets and liabilities consist of interest rate swaps and over-the-counter commodity and currency contracts.

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

 

17


Table of Contents

currency contracts are valued using an income approach based on forward rates less the contract rate multiplied by the notional amount. The Company’s calculation of the fair value of level 2 financial assets and liabilities takes into consideration the risk of nonperformance, including counterparty credit risk.

Level 3 – Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability. The Company did not have any level 3 financial assets or liabilities as of July 2, 2011 or January 1, 2011.

The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of July 2, 2011 and January 1, 2011:

 

      Level 1      Level 2      Total  
(millions)    July 2,
2011
     January 1,
2011
     July 2,
2011
     January 1,
2011
     July 2,
2011
     January 1,
2011
 

Derivatives designated as hedging instruments:

                 

Assets:

                 

Foreign currency exchange contracts:

                 

Other prepaid assets

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

Interest rate contracts:

                 

Other prepaid assets

     —          —          —                 —           

Other assets

     —          —          54         69         54        69   

Commodity contracts:

                 

Other prepaid assets

            23                —          6        23   

Total assets

     $  5         $ 23         $ 69         $ 81         $ 74        $ 104   

Liabilities:

                 

Foreign currency exchange contracts:

                 

Other current liabilities

     $—          $—          $(18)         $(27)         $(18)         $ (27)   

Interest rate contracts:

                 

Other liabilities

     —          —          (13)         —          (13)         —    

Commodity contracts:

                 

Other current liabilities

     (12)         —          (9)         (10)         (21)         (10)   

Other liabilities

     —          —          (25)         (29)         (25)         (29)   
                                                       

Total liabilities

     $(12)         $—          $(65)         $(66)         $(77)         $ (66)   
                                                       

Derivatives not designated as hedging instruments:

                 

Assets:

                 

Interest rate contracts:

                 

Other assets

     $—          $—          $26        $—          $26         $ —    

Total assets

     $—          $—          $26        $—          $26         $ —    
                                                       

 

18


Table of Contents

The effect of derivative instruments on the Consolidated Statement of Income for the quarters ended July 2, 2011 and July 3, 2010 was as follows:

 

Derivatives in fair value hedging
relationships (millions)
   Location of gain (loss)
recognized in income
   Gain (loss)
recognized in income
 
          July 2,
2011
    July 3,
2010
 

Foreign currency exchange contracts

   Other income (expense), net    $ 3     $ (22)   

Interest rate contracts

   Interest expense        12           10  

Total

        $ 15     $ (12)   
                       

 

Derivatives in cash flow hedging
relationships (millions)
  

Gain (loss)
recognized in

AOCI

    Location of
gain (loss)
reclassified
from AOCI
   Gain (loss)
reclassified from
AOCI into income
    Location of gain (loss)
recognized in income (a)
   Gain (loss)
recognized in income(a)
 
     July 2,
2011
    July 3,
2010
         July 2,
2011
    July 3,
2010
         July 2,
2011
       July 3,
2010
 

Foreign currency exchange contracts

   $ (1   $      COGS    $ (1   $ (6   Other income (expense), net    $         $   

Foreign currency exchange contracts

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

Interest rate contracts

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

Commodity contracts

     (32     (5   COGS      3       (11   Other income (expense), net        —             —   

Total

   $ (46   $ (4        $ 3     $ (18        $         $   
                                                               

 

Derivatives not designated as hedging
instruments (millions)
   Location of gain (loss)
recognized in income
  Gain (loss)
recognized in income
 
           July 2,  
2011
        July 3,    
2010
 

Foreign currency exchange contracts

   Other income (expense), net   $ 1     $   

Interest rate contracts

   Interest expense              

Total

       $ 1     $   
                      

 

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

 

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Table of Contents

The effect of derivative instruments on the Consolidated Statement of Income for the year-to-date periods ended July 2, 2011 and July 3, 2010 were as follows:

 

Derivatives in fair value hedging

relationships (millions)

  

Location of gain (loss)

recognized in income

  Gain (loss)
recognized in income
 
         July 2,
2011
     July 3,
2010
 

Foreign currency exchange contracts

   Other income (expense), net   $ 25      $ (51)   

Interest rate contracts

   Interest expense     27        20  

Total

       $ 52      $ (31)   
                       

 

Derivatives in cash flow hedging

relationships (millions)

   Gain (loss)
recognized in
AOCI
    Location of
gain (loss)
reclassified
from AOCI
   Gain (loss)
reclassified from
AOCI into income
   

Location of gain (loss)

recognized in income (a)

  Gain (loss)
recognized in income(a)
 
     July 2,
2011
    July 3,
2010
         July 2,
2011
    July 3,
2010
        July 2,
2011
    July 3,
2010
 

Foreign currency exchange contracts

   $ (3   $ (12   COGS    $ (3   $ (13   Other income (expense), net   $ (1   $   

Foreign currency exchange contracts

     (2     2     SGA expense                  Other income (expense), net              

Interest rate contracts

     (13          Interest expense      2       (2   N/A              

Commodity contracts

     (17     (29   COGS      12       (16   Other income (expense), net            (1
                                                           

Total

   $ (35   $ (39      $ 11     $ (31     $ (1   $ (1
                                                           
                                                           

 

Derivatives not designated as hedging

instruments (millions)

   Location of gain (loss)
recognized in income
  Gain (loss)
recognized in income
 
         July 2,
2011
    July 3,
2010
 

Foreign currency exchange contracts

   Other income (expense), net   $ 1     $   

Interest rate contracts

   Interest expense     (3       
                      

Total

     $ (2   $   
                      
                      

 

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

Certain of the Company’s derivative instruments contain provisions requiring the Company to post collateral on those derivative instruments that are in a liability position if the Company’s credit rating falls below BB+ (S&P), or Baa1 (Moody’s). The fair value of all derivative instruments with credit-risk-related contingent features in a liability position on July 2, 2011 was $33 million. If the credit-risk-related contingent features were triggered as of July 2, 2011, the Company would be required to post collateral of $33 million. In addition, certain derivative instruments contain provisions that would be triggered in the event the Company defaults on its debt agreements. There were no collateral posting requirements as of July 2, 2011 triggered by credit-risk-related contingent features.

 

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Table of Contents

Financial instruments

The carrying values of the Company’s short-term items, including cash, cash equivalents, accounts receivable, accounts payable and notes payable approximate fair value. The fair value of the Company’s long-term debt is calculated based on broker quotes and was as follows at July 2, 2011:

 

(millions)    Fair Value      Carrying Value  

Long-term debt

   $ 5,767      $ 5,308  
                   
                   

Credit risk concentration

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

Master netting agreements apply in situations where the Company executes multiple contracts with the same counterparty. Certain counterparties represent a concentration of credit risk to the Company. If those counterparties fail to perform according to the terms of derivative contracts, this would result in a loss to the Company of $48 million as of July 2, 2011.

For certain derivative contracts, reciprocal collateralization agreements with counterparties call for the posting of collateral in the form of cash, treasury securities or letters of credit if a fair value loss position to the Company or our counterparties exceeds a certain amount. There were no collateral balance requirements at July 2, 2011.

Management believes concentrations of credit risk with respect to accounts receivable is limited due to the generally high credit quality of the Company’s major customers, as well as the large number and geographic dispersion of smaller customers. However, the Company conducts a disproportionate amount of business with a small number of large multinational grocery retailers, with the five largest accounts encompassing approximately 28% of consolidated trade receivables at July 2, 2011.

Note 10 Product recall

On June 25, 2010, the Company announced a recall of select packages of Kellogg’s cereal in the U.S. due to an odor from waxy resins found in the package liner. Estimated customer returns and consumer rebates were recorded as a reduction of net sales; costs associated with returned product and the disposal and write-off of inventory were recorded as COGS; and other recall costs were recorded as SGA expenses. In addition to the costs of the recall, the Company also lost sales of the impacted products in the second quarter of 2010.

 

(millions, except per share amount)   

Quarter ended

July 3, 2010

 

Reduction of net sales

   $ 30  

Cost of goods sold

     18  
          

Total

   $ 48  
          

Earnings per diluted share impact

   $ 0.09  
          
          

Note 11 Operating segments

Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles, and veggie foods. Kellogg products are manufactured and marketed globally. Principal markets for these products include the United States and United Kingdom. The Company currently manages its operations in four geographic operating segments, comprised of North America and the three International operating segments of Europe, Latin America, and Asia Pacific.

 

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Table of Contents
     Quarter ended     Year-to-date
period ended
 
(millions)    July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 

Net sales

        

North America

   $ 2,231     $ 2,064     $ 4,595     $ 4,339  

Europe

     634       560       1,255       1,166  

Latin America

     281       240       542       462  

Asia Pacific (a)

     240       198       479       413  
                                  

Consolidated

   $ 3,386     $ 3,062     $ 6,871     $ 6,380  
                                  

Segment operating profit

        

North America (b)

   $ 406     $ 364     $ 846     $ 862  

Europe

     102       100       203       205  

Latin America

     61       47       109       92  

Asia Pacific (a)

     25       20       56       57  

Corporate (b)

     (51     (48     (99     (96
                                  

Consolidated

   $ 543     $ 483     $ 1,115     $ 1,120  
                                  
                                  

 

(a) Includes Australia, Asia and South Africa.
(b) Research and Development expense totaling $2 million for the quarter ended July 3, 2010 and $5 million for the year-to-date period ended July 3, 2010 was reallocated to Corporate from North America.

 

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Table of Contents

KELLOGG COMPANY

PART I—FINANCIAL INFORMATION

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

Results of operations

Overview

For more than 100 years, consumers have counted on Kellogg for great-tasting, high-quality and nutritious foods. Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles and veggie foods. Kellogg products are manufactured and marketed globally. We currently manage our operations in four geographic operating segments, consisting 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 net earnings per share on a currency-neutral basis. Internal net sales and internal operating profit exclude the impact of foreign currency translation, acquisitions, dispositions and shipping day differences. See the “Foreign currency translation” section for an explanation of management’s definition of currency neutral.

For the quarter ended July 2, 2011, our reported net sales increased 11% and internal net sales increased 6%. Consolidated operating profit increased 12%, while internal operating profit increased 8%. Diluted earnings per share (EPS) increased 19% to $0.94, compared to $0.79 in the comparable prior year quarter. EPS on a currency-neutral basis was up 13%. Our performance was in-line with our expectations for the quarter. We had strong top-line growth, driven by price execution, and invested in brand building and in our supply chain. We lapped a soft 2010 second quarter.

For the full year 2011, we expect our internal net sales to increase by approximately 4-5%. We are on track to meet our internal operating profit guidance of flat to down 2%, and our currency-neutral earnings per diluted share growth of low single-digits (1 to 3%).

Net sales and operating profit

The following table provides an analysis of net sales and operating profit performance for the second quarter of 2011 versus 2010:

 

(dollars in millions)    North
America
    Europe     Latin
America
    Asia
Pacific
(a)
    Corporate     Consoli-
dated
 

2011 net sales

   $ 2,231     $ 634     $ 281     $ 240     $     $ 3,386  
                                                  

2010 net sales

   $ 2,064     $ 560     $ 240     $ 198     $     $ 3,062  
                                                  

% change — 2011 vs. 2010:

            

Volume (tonnage) (b)

     1.9     (3.1 )%      (.6 )%      .2            .6

Pricing/mix

     5.6     3.7     7.7     3.6            5.4

Subtotal — internal business

     7.5     .6     7.1     3.8            6.0

Foreign currency impact

     .6     12.7     10.3     16.6            4.6

Total change

     8.1     13.3     17.4     20.4            10.6
(dollars in millions)   

North
America

(c)

    Europe     Latin
America
   

Asia
Pacific

(a)

   

Corporate

(c)

    Consoli-
dated
 

2011 operating profit