Kellogg Company 10-Q 2014
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2014
For the transition period from to
Commission file number 1-4171
One Kellogg Square, P.O. Box 3599, Battle Creek, MI 49016-3599
Registrants 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Common Stock outstanding as of October 25, 2014 355,033,895 shares
Item 1. Financial Statements.
CONSOLIDATED BALANCE SHEET
(millions, except per share data)
Refer to Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF INCOME
(millions, except per share data)
Refer to Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Refer to Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF EQUITY
Refer to Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
Refer to Notes to Consolidated Financial Statements.
for the quarter ended September 27, 2014 (unaudited)
Note 1 Accounting policies
Basis of presentation
The unaudited interim financial information of Kellogg Company (the Company) included in this report reflects normal recurring adjustments that management believes are necessary for a fair statement of the results of operations, comprehensive income, financial position, equity and cash flows for the periods presented. This interim information should be read in conjunction with the financial statements and accompanying footnotes within the Companys 2013 Annual Report on Form 10-K.
The condensed balance sheet data at December 28, 2013 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the quarterly period ended September 27, 2014 are not necessarily indicative of the results to be expected for other interim periods or the full year.
Beginning in 2014, the Company has an agreement with a third party to provide an accounts payable tracking system which facilitates participating suppliers ability to monitor, and if elected, sell to designated third-party financial institutions, payment obligations of the Company. Participating suppliers may, at their sole discretion, make offers to sell one or more payment obligations of the Company prior to their scheduled due dates at a discounted price to participating financial institutions. The Companys goal in entering into this agreement is to capture overall supplier savings, in the form of pricing, payment terms or vendor funding, created by facilitating suppliers ability to sell receivables, while providing them with greater working capital flexibility. We have no economic interest in the sale of these suppliers receivables and no direct financial relationship with the financial institutions concerning these services. The Companys obligations to its suppliers, including amounts due and scheduled payment dates, are not impacted by suppliers decisions to sell amounts under this arrangement. However, the Companys right to offset balances due from suppliers against payment obligations is restricted by this agreement for those payment obligations that have been sold by suppliers. As of September 27, 2014, $188 million of the Companys outstanding payment obligations had been placed in the accounts payable tracking system, and participating suppliers had sold $139 million of those payment obligations to participating financial institutions.
New accounting standards
Presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. In July 2013, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance on financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU is expected to eliminate diversity in practice resulting from lack of previously existing guidance. It applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date. The Company adopted the revised guidance on a prospective basis at the beginning of its 2014 fiscal year, with no significant impact to the Consolidated Financial Statements.
Accounting standards to be adopted in future periods
In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance for accounting for revenue from contracts with customers. The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity would be required to apply the following five steps: 1) identify the contract(s) with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. Entities will have the option to apply the final standard retrospectively or use a modified retrospective method, recognizing the cumulative effect of the ASU in retained earnings at the date of initial application. An entity will not restate prior periods if it uses the modified retrospective method, but will be required to disclose the amount by which each financial statement line item is affected in the current reporting period by the application of the ASU as compared to the guidance in effect prior to the change, as well as reasons for significant
changes. The Company will adopt the updated standard in the first quarter of 2017. The Company is currently evaluating the impact that implementing this ASU will have on its financial statements and disclosures, as well as whether it will use the retrospective or modified retrospective method of adoption.
Note 2 Goodwill and other intangible assets
Changes in the carrying amount of goodwill for the year-to-date period ended September 27, 2014, are presented in the following table:
Carrying amount of goodwill
Intangible assets subject to amortization
* Certain fully amortized intangible assets which were no longer utilized by the Company have been written off and revised in the prior period presentation. The impact to reporting segments are as follows (millions): U.S. Morning Foods - $20; U.S. Snacks - $5; Europe - $2; and Latin America - $1.
For intangible assets in the preceding table, amortization was $6 million for both the year-to-date periods ended September 27, 2014 and September 28, 2013. The currently estimated aggregate annual amortization expense for full-year 2014 and each of the four succeeding fiscal years is approximately $9 million.
Intangible assets not subject to amortization
Note 3 Restructuring and cost reduction activities
The Company views its continued spending on restructuring and cost reduction activities as part of its ongoing operating principles to provide greater visibility in achieving its long-term profit growth targets. Initiatives undertaken are currently expected to recover cash implementation costs within a five-year period of completion. Upon completion (or as each major stage is completed in the case of multi-year programs), the project begins to deliver cash savings and/or reduced depreciation.
The Company has initiated a number of restructuring and cost reduction activities. The most recent and largest program that is currently active is Project K, a four-year efficiency and effectiveness program announced in November 2013. The program is expected to generate a significant amount of savings that will be invested in key strategic areas of focus for the business. The Company expects that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow.
The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories.
During the quarter ended September 27, 2014, the Company recorded total charges of $92 million across all restructuring and cost reduction activities. The charges were comprised of $64 million being recorded in cost of goods sold (COGS) and $28 million recorded in selling, general and administrative (SGA) expense. During the year-to-date period ended September 27, 2014, the Company recorded total charges of $224 million across all restructuring and cost reduction activities. The charges were comprised of $120 million being recorded in COGS and $104 million recorded in SGA expense.
During the quarter ended September 28, 2013 the Company recorded total charges of $29 million across all restructuring and cost reduction activities. The charges were comprised of $12 million being recorded in COGS and $17 million recorded in SGA expense. During the year-to-date period ended September 28, 2013 the Company recorded total charges of $49 million across all restructuring and cost reduction activities. The charges were comprised of $23 million being recorded in COGS and $26 million recorded in SGA expense.
The tables below provide the details for charges across all restructuring and cost reduction activities incurred during the quarters and year-to-date periods ended September 27, 2014 and September 28, 2013 and program costs to date for programs currently active as of September 27, 2014.
For the quarter and year-to-date periods ended September 27, 2014, and September 28, 2013, employee related costs consist primarily of severance benefits, asset related costs consist primarily of accelerated depreciation, and other costs consist primarily of third-party incremental costs related to the development and implementation of global business capabilities.
The Company currently anticipates that Project K will result in total pre-tax charges, once all phases are approved and implemented, of $1.2 to $1.4 billion, with after-tax cash costs, including incremental capital expenditures, estimated to be $900 million to $1.1 billion. The Company currently expects the charges will consist of asset-related costs totaling $450 to $500 million which will consist primarily of asset impairments, accelerated depreciation and other exit-related costs; employee-related costs totaling $425 to $475 million which will include severance, pension and other termination benefits; and other costs totaling $325 to $425 million which will consist primarily of charges related to the design and implementation of global business capabilities. A significant portion of other costs are the result of the implementation of global business service centers which are intended to simplify and standardize business support processes. Costs incurred to date related to Project K through September 27, 2014 totaled $419 million.
The Company currently expects that total pre-tax charges will impact reportable segments as follows: U.S. Morning Foods (approximately 17%), U.S. Snacks (approximately 10%), U.S. Specialty (approximately 1%), North America Other (approximately 3%), Europe (approximately 12%), Latin America (approximately 3%), Asia-Pacific (approximately 6%), and Corporate (approximately 48%). A majority of the costs impacting Corporate relate to additional initiatives to be executed after 2014 that are currently not fully defined. As the development of these initiatives is completed, the Company will update its estimated costs by reportable segment as needed.
At September 27, 2014 reserves for all restructuring and cost reduction activities are reflected in the table below. A substantial portion of these reserves will be paid out in 2014 and 2015 related to severance payments and other costs.
Note 4 Equity
Earnings per share
Basic earnings per share is determined by dividing net income attributable to Kellogg Company by the weighted average number of common shares outstanding during the period. Diluted earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares consist principally of employee stock options issued by the Company, and to a lesser extent, certain contingently issuable performance shares. Basic earnings per share is reconciled to diluted earnings per share in the following tables. There were zero and 5 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended September 27, 2014, respectively. There were 6 million and 5 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended September 28, 2013, respectively.
Quarters ended September 27, 2014 and September 28, 2013:
Year-to-date periods ended September 27, 2014 and September 28, 2013:
In February 2014, the Companys board of directors approved a share repurchase program authorizing the repurchase of up to $1.5 billion of common stock through December 2015. This authorization supersedes the April 2013 authorization and is intended to allow the Company to repurchase shares for general corporate purposes and to offset issuances for employee benefit programs.
During the year-to-date period ended September 27, 2014, the Company repurchased approximately 11 million shares of common stock for a total of $690 million. During the year-to-date period ended September 28, 2013, the Company repurchased approximately 9 million shares of common stock for a total of $544 million.
Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by or distributions to shareholders. Other comprehensive income consists of foreign currency translation adjustments, fair value adjustments associated with cash flow hedges and adjustments for net experience losses and prior service cost related to employee benefit plans.
Prior service credits arising during the period resulted from a change in post-retirement benefits provided to certain employees.
Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended September 27, 2014 consisted of the following:
Reclassifications out of AOCI for the quarter and year-to-date periods ended September 28, 2013 consisted of the following:
Accumulated other comprehensive income (loss) as of September 27, 2014 and December 28, 2013 consisted of the following:
Note 5 Debt
The following table presents the components of notes payable at September 27, 2014 and December 28, 2013:
In the third quarter of 2014, the Company terminated interest rate swaps with notional amounts totaling $500 million, which were designated as fair value hedges of its 1.875% fixed rate U.S. Dollar Notes due 2016. The interest rate swaps effectively converted the interest rate on the Notes from fixed to variable and the unrealized loss upon termination of $2 million will be amortized to interest expense over the remaining term of the Notes.
In May 2014, the Company issued 500 million (approximately $636 million USD at September 27, 2014, which reflects the discount and translation adjustments) of seven-year 1.75% Euro Notes due 2021, using the proceeds from these Notes for general corporate purposes, which included repayment of a portion of the Companys commercial paper borrowings. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions, as well as a change of control provision. The Notes were designated as a net investment hedge of the Companys investment in its Europe subsidiary when issued.
In May 2014, the Company issued Cdn. $300 million (approximately $271 million USD at September 27, 2014, which reflects the discount and translation adjustments) of three-year 2.05% Canadian Dollar Notes due 2017, using the proceeds from these Notes, together with cash on hand, to repay the Companys Cdn. $300 million, 2.10% Notes due May 22, 2014 at maturity. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions, as well as a change of control provision.
In February 2014, the Company entered into an unsecured Five-Year Credit Agreement to replace its existing unsecured Four-Year Credit Agreement, which would have expired in March 2015. The Five-Year Credit Agreement allows the Company to borrow, on a revolving credit basis, up to $2.0 billion, which includes the ability to obtain letters of credit in an aggregate stated amount not to exceed $75 million and swingline loans in aggregate principal amounts up to $200 million in U.S. dollars and $400 million in Euros. The agreement contains customary covenants and warranties, including specified restrictions on indebtedness, liens and a specified interest coverage ratio. If an event of default occurs, then, to the extent permitted, the administrative agent may terminate the commitments under the credit facility, accelerate any outstanding loans under the agreement, and demand the deposit of cash collateral equal to the lenders letter of credit exposure plus interest.
In March 2014, the Company redeemed $150 million of its 4.0% U.S. Dollar Notes due 2020, $342 million of its 3.125% U.S. Dollar Debentures due 2022 and $189 million of its 2.75% U.S. Dollar Notes due 2023. In connection with the debt redemption, the Company incurred $1 million of interest expense, offset by $8 million of accelerated gains on interest rate
hedges previously recorded in accumulated other comprehensive income, and incurred $5 million of expense, recorded in Other Income, Expense (net), related to acceleration of fees on the redeemed debt and fees related to the tender offer.
The Company has entered into interest rate swaps with notional amounts totaling $2.4 billion, which effectively converts a portion of the associated U.S. Dollar Notes from fixed rate to floating rate obligations. These derivative instruments are designated as fair value hedges. The effective interest rates on debt obligations resulting from the Companys interest rate swaps as of September 27, 2014 were as follows: (a) seven-year 4.45% U.S. Dollar Notes due 2016 3.42%; (b) five-year 1.875% U.S. Dollar Notes due 2016 1.58%; (c) five-year 1.75% U.S. Dollar Notes due 2017 - 1.32%; (d) seven-year 3.25% U.S. Dollar Notes due 2018 1.84%; (e) ten-year 4.15% U.S. Dollar Notes due 2019 - 2.71%; (f) ten-year 4.00% U.S. Dollar Notes due 2020 - 2.09%; (g) ten-year 3.125% U.S. Dollar Notes due 2022 - 1.32%.
Note 6 Stock compensation
The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, and to a lesser extent, executive performance shares, restricted stock units and restricted stock grants. The Company also sponsors a discounted stock purchase plan in the United States and matching-grant programs in several international locations. Additionally, the Company awards restricted stock to its outside directors. The interim information below should be read in conjunction with the disclosures included within the stock compensation footnote of the Companys 2013 Annual Report on Form 10-K.
The Company classifies pre-tax stock compensation expense in SGA expense principally within its corporate operations. For the periods presented, compensation expense for all types of equity-based programs and the related income tax benefit recognized were as follows:
As of September 27, 2014, total stock-based compensation cost related to non-vested awards not yet recognized was $51 million and the weighted-average period over which this amount is expected to be recognized was 2 years.
During the year-to-date periods ended September 27, 2014 and September 28, 2013, the Company granted non-qualified stock options to eligible employees as presented in the following activity tables. Terms of these grants and the Companys methods for determining grant-date fair value of the awards were consistent with that described within the stock compensation footnote in the Companys 2013 Annual Report on Form 10-K.
Year-to-date period ended September 27, 2014:
Year-to-date period ended September 28, 2013:
The weighted-average fair value of options granted was $6.70 per share and $5.92 per share for the year-to-date periods ended September 27, 2014 and September 28, 2013, respectively. The fair value was estimated using the following assumptions:
The total intrinsic value of options exercised was $44 million and $133 million for the year-to-date periods ended September 27, 2014 and September 28, 2013, respectively.
In the first quarter of 2014, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Companys common stock on the vesting date, provided cumulative three-year operating profit and internal net sales growth targets are achieved.
The 2014 target grant currently corresponds to approximately 223,000 shares, with a grant-date fair value of $54 per share. The actual number of shares issued on the vesting date could range from 0 to 200% of target, depending on actual performance achieved. Based on the market price of the Companys common stock at September 27, 2014, the maximum future value that could be awarded to employees on the vesting date for all outstanding performance share awards was as follows:
The 2011 performance share award, payable in stock, was settled at 60% of target in February 2014 for a total dollar equivalent of $3 million.
Note 7 Employee benefits
The Company sponsors a number of U.S. and foreign pension plans, as well as other nonpension postretirement and postemployment plans to provide various benefits for its employees. These plans are described within the footnotes to the Consolidated Financial Statements included in the Companys 2013 Annual Report on Form 10-K. Components of Company plan benefit expense for the periods presented are included in the tables below.
During the quarter ended September 27, 2014, the Company recognized a curtailment gain of $12 million in conjunction with Project K restructuring activity. In addition, the Company remeasured the benefit obligation for the impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate.
Company contributions to employee benefit plans are summarized as follows:
Plan funding strategies may be modified in response to managements evaluation of tax deductibility, market conditions, and competing investment alternatives.
Note 8 Income taxes
The consolidated effective tax rate for the quarters ended September 27, 2014 and September 28, 2013 were 27.7% and 27.4%, respectively. The consolidated effective tax rate for both year-to-date periods ended September 27, 2014 and September 28, 2013 was 28.6%.
As of September 27, 2014, the Company classified $6 million of unrecognized tax benefits as a net current liability. Managements estimate of reasonably possible changes in unrecognized tax benefits during the next twelve months is comprised of the current liability balance which is expected to be settled within one year, offset by approximately $8 million of projected additions related primarily to ongoing intercompany transfer pricing activity. Management is currently
unaware of any issues under review that could result in significant additional payments, accruals or other material deviation in this estimate.
Following is a reconciliation of the Companys total gross unrecognized tax benefits for the year-to-date period ended September 27, 2014; $61 million of this total represents the amount that, if recognized, would affect the Companys effective income tax rate in future periods.
For the year-to-date period ended September 27, 2014 the Company recognized an increase of $3 million for tax-related interest and penalties. The Company recognized no cash settlements during the current quarter. The accrual balance was $20 million at September 27, 2014.
Note 9 Derivative instruments and fair value measurements
The Company is exposed to certain market risks such as changes in interest rates, foreign currency exchange rates, and commodity prices, which exist as a part of its ongoing business operations. Management uses derivative and non-derivative financial instruments and commodity instruments, including futures, options, and swaps, where appropriate, to manage these risks. Instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged.
The Company designates derivatives as cash flow hedges, fair value hedges, net investment hedges, and uses other contracts to reduce volatility in interest rates, foreign currency and commodities. As a matter of policy, the Company does not engage in trading or speculative hedging transactions.
Total notional amounts of the Companys derivative instruments as of September 27, 2014 and December 28, 2013 were as follows:
Following is a description of each category in the fair value hierarchy and the financial assets and liabilities of the Company that were included in each category at September 27, 2014 and December 28, 2013, measured on a recurring basis.
Level 1 Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market. For the Company, level 1 financial assets and liabilities consist primarily of commodity derivative contracts.
Level 2 Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. For the Company, level 2 financial assets and liabilities consist of interest rate swaps and over-the-counter commodity