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)
OR
Commission file number 1-4171
KELLOGG COMPANY
One Kellogg Square, P.O. Box 3599, Battle Creek, MI 49016-3599
Registrant’s telephone number: 616-961-2000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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
Common Stock outstanding July 31, 2002 — 410,095,658 shares
TABLE OF CONTENTS
INDEX
Kellogg Company and SubsidiariesCONSOLIDATED BALANCE SHEET(millions, except per share data)
* Condensed from audited financial statements
Refer to Notes to Consolidated Financial Statements
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Kellogg Company and SubsidiariesCONSOLIDATED EARNINGS(millions, except per share data)
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Kellogg Company and SubsidiariesCONSOLIDATED STATEMENT OF CASH FLOWS(millions)
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Notes to Consolidated Financial Statementsfor the quarter and year-to-date period ended June 29, 2002 (unaudited)
Note 1 Accounting policies
The unaudited interim financial information included in this report reflects normal recurring adjustments that management believes are necessary for a fair presentation of the results of operations, financial position, 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 43 of the Company’s 2001 Annual Report. The accounting policies used in preparing these financial statements are the same as those summarized in the Company’s 2001 Annual Report, except as discussed below. Certain amounts for 2001 have been reclassified to conform to current-period classifications. The results of operations for the quarter and year-to-date period ended June 29, 2002 are not necessarily indicative of the results to be expected for other interim periods or the full year.
Interim reporting periods
Historically, the Company has reported interim periods on a calendar-quarter basis. Certain business units within the Company have followed a thirteen week quarter convention, commonly referred to as “4-4-5” because of the number of weeks in each sub-period of the quarter. In order to facilitate conversion to SAP software and to achieve greater consistency and efficiency, all business units of the Company are reporting interim results on a “4-4-5” basis beginning in 2002. Because prior-year results have not been restated, year-over-year comparability of quarterly results could be significantly impacted, due principally to the change in reporting dates for the Keebler business. Keebler’s 2001 interim results were reported for the periods ended March 24, June 16, October 6, and December 29; whereas, 2002 interim results are being reported for the periods ended March 30, June 29, September 28, and December 28. Guidance will be provided within Management’s Discussion and Analysis regarding any significant impact of this reporting change on year-over-year comparisons.
Classification of promotional expenditures
Beginning January 1, 2002, the Company has applied the consensus reached by the Emerging Issues Task Force (EITF) of the FASB in Issue No. 01-09 “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products.” Under this consensus, generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. Non-cash consideration is to be classified as a cost of sales.
As a result of applying this consensus, the Company has reclassified promotional payments to its customers and the cost of consumer coupons and other cash redemption offers from selling, general, and administrative expense (SGA) to net sales. The Company has reclassified the cost of promotional package inserts and other non-cash consideration from SGA to cost of goods sold. Prior-period financial statements have been reclassified to comply with this guidance.
Goodwill and other intangible assets
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets” on January 1, 2002. This standard provides accounting and disclosure guidance for acquired intangibles. Under this standard, goodwill and “indefinite-lived” intangibles are no longer amortized, but are tested at least annually for impairment. If the asset is determined to be impaired, an impairment loss would be recognized within the Company’s operating profit to reduce carrying value to fair value. Transitional impairment tests of goodwill and non-amortized intangibles are also performed upon adoption of SFAS No. 142, with any recognized impairment loss reported as the cumulative effect of an accounting change in the first period of adoption. The Company was not required to recognize any impairment losses under these transitional tests.
SFAS No. 142 also provides separability criteria for recognizing intangible assets apart from goodwill. Under these provisions, assembled workforce is no longer considered a separate intangible. Accordingly, for the quarter ended March 30, 2002, the Company reclassified approximately $46 million from other intangibles to goodwill on the balance sheet. Refer to Note 7 for further information on the Company’s goodwill and other intangible assets.
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The provisions of SFAS No. 142 are adopted prospectively and prior-period financial statements are not restated. Comparative earnings information for prior periods is presented in the following table:
Accounting for long-lived assets
The Company adopted SFAS No. 144 “Accounting for Impairment or Disposal of Long-lived Assets” on January 1, 2002. This standard is generally effective for the Company on a prospective basis.
SFAS No. 144 clarifies and revises existing guidance on accounting for impairment of plant, property, and equipment, amortized intangibles, and other long-lived assets not specifically addressed in other accounting literature. Significant changes include 1) establishing criteria beyond those previously specified in existing literature for determining when a long-lived asset is held for sale, and 2) requiring that the depreciable life of a long-lived asset to be abandoned is revised. These provisions could be expected to have the general effect of reducing or delaying recognition of future impairment losses on assets to be disposed, offset by higher depreciation expense during the remaining holding period. However, management does not expect the adoption of this Standard to have a significant impact on the Company’s 2002 financial results. SFAS No. 144 also broadens the presentation of discontinued operations to include a component of an entity (rather than only a segment of a business).
Accounting for exit costs
In July 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal”, which is effective for exit or disposal activities initiated after December 31, 2002, with early application encouraged. The Company currently plans to adopt SFAS No. 146 for its 2003 fiscal year.
This Statement is intended to achieve consistency in timing of recognition between exit costs, such as one-time employee separation benefits and contract termination payments, and all other costs. Under existing literature, certain costs associated with exit activities are recognized when management commits to a plan. Under SFAS No. 146, costs will be recognized when a liability has been incurred under general concepts. For instance, under existing literature, plant closure costs would be accrued at the plan commitment date. Under SFAS No. 146, these costs would be recognized as closure activities are performed. These provisions could be expected to have the general effect of delaying recognition of certain costs related to restructuring programs. However, management does not currently expect adoption of this Standard to have a significant impact on the Company’s 2003 financial results.
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Note 2 Acquisitions and dispositions
Keebler
On March 26, 2001, the Company acquired Keebler Foods Company (“Keebler”) in a cash transaction valued at $4.56 billion. The acquisition was accounted for under the purchase method and was financed through a combination of short-term and long-term debt.
The components of intangible assets included in the final allocation of purchase price are presented in the following table. During 2001, these intangibles were amortized based on an estimated useful life of 40 years. As a result of the Company’s adoption of SFAS No. 142 on January 1, 2002 (refer to Note 1), these intangibles are no longer amortized after 2001, but are subject to annual impairment reviews.
The final purchase price allocation includes $80.1 million of liabilities related to management’s plans, as of the acquisition date, to exit certain activities and operations of the acquired company, as presented in the table below. Cash outlays related to these exit plans were $28 million in 2001 and are projected to be approximately $31 million in 2002, with the remaining amounts spent principally during 2003.
Management’s exit plans are being announced as individual initiatives are implemented. During April 2002, the Company sold certain assets of Keebler’s Bake-Line private-label unit, including a bakery in Marietta, Oklahoma, to Atlantic Baking Group, Inc for approximately $65 million in cash and a $10 million note to be paid at a later date. The carrying value of net assets sold, including allocated goodwill, approximated the net sales proceeds.
Other
In June 2000, the Company paid cash to acquire the outstanding stock of Kashi Company, a U.S. natural foods company. During the quarter ended June 29, 2002, the Company paid additional contingent purchase price of $2 million, bringing the total purchase price, including related acquisition costs, to approximately $35 million.
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Note 3 Restructuring and other charges
Cost of goods sold for the quarter ended June 29, 2002, includes an impairment loss of $5.0 million related to the Company’s manufacturing facility in China, representing a decline in real estate market value subsequent to an original impairment loss recognized for this property in 1997.
Operating profit for the year-to-date period ended June 30, 2001, includes restructuring charges of $48.3 million ($30.3 million after tax or $.07 per share), related to preparing Kellogg for the Keebler integration and continued actions supporting the Company’s “focus and align” strategy in the United States and Asia. Approximately 70% of the charges were comprised of asset write-offs, with the remainder consisting of employee severance and other cash costs. At December 31, 2001, remaining reserves for cash expenditures related to all of the Company’s prior-years’ restructuring initiatives were approximately $10 million (refer to page 34 of the Company’s 2001 Annual Report for further information), which are expected to be spent during 2002.
Net earnings for the year-to-date period ended June 30, 2001, include an extraordinary loss of $7.4 million, net of tax benefit of $4.2 million, ($.02 per share) related to the extinguishment of $400 million of long-term debt. In April 2002, the FASB issued SFAS No. 145, a technical corrections pronouncement which, in part, rescinds SFAS No. 4 “Reporting Gains and Losses from Extinguishment of Debt.” Under SFAS No. 145, generally, debt extinguishments will no longer be classified as extraordinary items. This standard will be effective for the Company for its 2003 fiscal year. Upon adoption, prior periods will be restated to conform to current period presentation.
On January 1, 2001, the Company adopted SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”. For the year-to-date period ended June 30, 2001, the Company reported a charge to earnings of $1.0 million, net of tax benefit of $.6 million, and a charge to other comprehensive income of $14.9 million, net of tax benefit of $8.6 million, in order to recognize the fair value of derivative instruments as either assets or liabilities on the balance sheet.
Note 4 Other income (expense), net
Other income (expense), net includes non-operating items such as interest income, foreign exchange gains and losses, charitable donations, and gains on assets sales. Other income (expense), net for the quarter ended March 30, 2002, includes a $16.5 million credit ($10.2 million after tax or $.02 per share), related to legal settlements.
Note 5 Equity
Earnings per share
Basic net earnings per share is determined by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted net earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares are comprised principally of employee stock options issued by the Company. Basic net earnings per share is reconciled to diluted net earnings per share as follows:
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Comprehensive Income
Comprehensive income includes net earnings and all other changes in equity during a period except those resulting from investments by or distributions to shareholders. Accumulated other comprehensive income for the periods presented consists of foreign currency translation adjustments pursuant to SFAS No. 52 “Foreign Currency Translation”, unrealized gains and losses on cash flow hedges pursuant to SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”, and minimum pension liability adjustments.
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Accumulated other comprehensive income (loss) as of June 29, 2002 and December 31, 2001 consisted of the following:
Note 6 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, frozen waffles, meat alternatives, pie crusts, and ice cream cones. Kellogg products are manufactured in 19 countries and marketed in more than 160 countries around the world. Principal markets for these products include the United States and United Kingdom.
The Company is managed in two major divisions — the United States and International — with International further delineated into Europe, Latin America, Canada, Australia, and Asia. This organizational structure is the basis of the operating segment data presented below. During 2001, the Company’s measure of operating segment profitability was defined as “operating profit excluding restructuring charges and Keebler amortization expense,” with operating profit determined in conformity with the presentation within the Consolidated Statement of Earnings. On January 1, 2002, the Company adopted SFAS No. 142 (refer to Note 1). Under the provisions of this standard, substantially all of the Company’s amortization expense was eliminated in periods subsequent to adoption. While this standard precludes restatement of prior-period financial statements, management’s measure of operating segment profitability has been restated for all prior periods to conform to the current-period presentation.
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Note 7 Supplemental information on goodwill and other intangible assets
Intangible assets subject to amortization (a):
Intangible assets not subject to amortization (a):
Changes in the carrying amount of goodwill for the period ended June 29, 2002 (a):
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PART I — FINANCIAL INFORMATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of operations
Overview
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, meat alternatives, pie crusts, and ice cream cones. Kellogg products are manufactured in 19 countries and marketed in more than 160 countries around the world. Our company is managed in two major divisions — the United States and International — with International further delineated into Europe, Latin America, Canada, Australia, and Asia. This organizational structure is the basis of the operating segment data presented in this report.
For the current period, our company achieved solid performance in several key metrics: sales growth, expansion of gross profit margin, and increased year-to-date cash flow. We believe improved execution, increased brand-building investment, and a focus on value over volume were important drivers of this performance.
The following items affect the comparability of current and prior-period results:
Reported results are reconciled to results adjusted for these items, as follows:
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The year-to-date increase in adjusted net earnings per share of $.10 was comprised of $.11 of business growth, $.05 from a reduced effective income tax rate, and $.02 from favorable legal settlements, partially offset by $.07 from increased interest expense and $.01 from a higher level of diluted shares outstanding.
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Net sales and operating profit
The following table provides an analysis of net sales and operating profit performance for the quarter ended June 29, 2002.
During the second quarter of 2002, we achieved strong internal sales growth of approximately 4% on a consolidated basis, resulting primarily from pricing and mix improvements in all operating segments. In particular, U.S. net sales in the retail cereal business increased approximately 6% and total international sales increased approximately 4% on a local currency basis. Adjusting the prior period for shipping day differences, the Bake-Line divestiture and Keebler integration impact, U.S. net sales in the retail snacks business increased approximately 3%.
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For the quarter, internal operating profit also increased approximately 4%, as gross margin expansion more than offset brand-building marketing expenditures on a consolidated basis. An internal growth rate of nearly 10% for our U.S. segment was partially offset by a decline of approximately 3% in total international results, related primarily to increased marketing expenditures in Europe, Australia, and Canada, and an asset impairment loss of $5 million in Asia. (Refer to “Restructuring and other charges” section below for further information.)
During the second quarter of 2001, net sales and operating profit were reduced by the financial impact of Keebler integration activities. During the quarter, this integration impact consisted primarily of the sales and gross profit impact of lowering trade inventories in order to transfer Kellogg snack foods to Keebler’s direct store door delivery (DSD) system, and employee-related costs such as relocation and retention. We estimate that these activities reduced net sales by $17.8 million, reduced gross profit by $16.4 million, and increased selling, general, and administrative expense by $5.1 million, for a total operating profit reduction of $21.5 million. The absence of these unfavorable impacts in the second quarter of 2002 improved current period consolidated net sales and operating profit by approximately 1% and 7%, respectively, versus the prior period.
The following table provides an analysis of net sales and operating profit performance for the year-to-date period ended June 29, 2002.
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Margin performance
Margin performance for the quarter and year-to-date periods ended June 29, 2002, is presented in the following table. All results for 2001 exclude the impact of restructuring charges and amortization expense that would have been eliminated if SFAS No. 142 had been applied in the prior year. Results for 2001 have also been restated for the retroactive application of EITF 01-09 (refer to Note 1 within Notes to Consolidated Financial Statements) related to the reclassification of certain promotional expenditures from selling, general, and administrative expense (SGA) to net sales.
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The 2002 gross margin improvement was primarily attributable to higher average pricing, improved mix, operating leverage, and cost synergies related to the Keebler acquisition.
Interest expense
For the year-to-date period ended June 29, 2002, gross interest expense, prior to amounts capitalized, increased versus the prior year, due primarily to interest expense on debt issued late in the first quarter of 2001 to finance the Keebler acquisition.
Other income (expense), net
Income taxes
The effective income tax rate for all interim periods of 2001 anticipated the estimated full-year impact of the Keebler acquisition on nondeductible goodwill and the level of U.S. tax on foreign subsidiary earnings. On a full-year basis, the 2001 effective income tax rate was 40%. As a result of our adoption of SFAS No. 142 on January 1, 2002, (refer to Note 1 within Notes to Consolidated Financial Statements), goodwill amortization expense — and the resulting impact on the effective income tax rate — has been eliminated in periods subsequent to adoption. Accordingly, the year-to-date 2002 effective income tax rate has been reduced to approximately 37%, which is consistent with our expectation for the full year.
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Restructuring and other charges
Operating profit for the year-to-date period ended June 30, 2001, includes restructuring charges of $48.3 million ($30.3 million after tax or $.07 per share), related to preparing Kellogg for the Keebler integration and continued actions supporting our “focus and align” strategy in the United States and Asia. Approximately 70% of the charges were comprised of asset write-offs, with the remainder consisting of employee severance and other cash costs. At December 31, 2001, remaining reserves for cash expenditures related to all of our prior-years’ restructuring initiatives were approximately $10 million (refer to page 34 of our Company’s 2001 Annual Report for further information), which are expected to be spent during 2002.
Net earnings for the year-to-date period ended June 30, 2001, include an extraordinary loss of $7.4 million, net of tax benefit of $4.2 million, ($.02 per share) related to the extinguishment of $400 million of long-term debt. In April 2002, the FASB issued SFAS No. 145, a technical corrections pronouncement which, in part, rescinds SFAS No. 4 “Reporting Gains and Losses from Extinguishment of Debt.” Under SFAS No. 145, generally, debt extinguishments will no longer be classified as extraordinary items. Upon our adoption of this standard for our 2003 fiscal year, prior periods will be restated to conform to current period presentation.
On January 1, 2001, we adopted SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”. For the year-to-date period ended June 30, 2001, we reported a charge to earnings of $1.0 million, net of tax benefit of $.6 million, and a charge to other comprehensive income of $14.9 million, net of tax benefit of $8.6 million, in order to recognize the fair value of derivative instruments as either assets or liabilities on the balance sheet.
Acquisitions and dispositions
On March 26, 2001, we acquired Keebler Foods Company in a cash transaction valued at $4.56 billion. The acquisition was accounted for under the purchase method and was financed through a combination of short-term and long-term debt.
The final purchase price allocation includes $80.1 million of liabilities related to our plans, as of the acquisition date, to exit certain activities and operations of the acquired company. Cash outlays related to these exit plans were approximately $28 million in 2001 and are projected to be approximately $31 million in 2002, with the remaining amounts spent principally during 2003.
Our exit plans are being announced as individual initiatives are implemented. During April 2002, we sold certain assets of Keebler’s Bake-Line private-label unit, including a bakery in Marietta, Oklahoma, to Atlantic Baking Group, Inc for approximately $65 million in cash and a $10 million note to be paid at a later date. The carrying value of net assets sold, including allocated goodwill, approximated the net sales proceeds.
In June 2000, we paid cash to acquire the outstanding stock of Kashi Company, a U.S. natural foods company. During the quarter ended June 29, 2002, we paid additional contingent purchase price of $2 million, bringing the total purchase price, including related acquisition costs, to approximately $35 million.
Liquidity and capital resources
For the year-to-date period ended June 29, 2002, net cash provided by operating activities was $563.7 million, compared to $418.7 million in the prior-year period. Operating cash flow for the prior-year period was reduced by an $88 million payment to settle interest rate hedges, related to debt issued to finance the Keebler
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acquisition. Operating cash flow for the current period exceeded the prior-period amount by $145.0 million, due primarily to this hedge settlement in 2001 and higher cash earnings in 2002, partially offset by the after-tax impact of a $150 million interest payment in the current period. Our management of “core working capital” (trade receivables and inventory, less trade payables) continues to improve as a percentage of sales. For the year-ended June 29, 2002, average core working capital represented 9.1% of net sales, versus 11.3% for year-ended June 30, 2001.
Year-to-date expenditures for property additions were $85.6 million, which represented 2.0% of year-to-date 2002 net sales compared with 3.7% for the full year of 2001. (The 2001 ratio has been restated for the retroactive application of EITF No. 01-09. Refer to Note 1 within Notes to Consolidated Financial Statements for further information). It is our goal to reduce full-year 2002 expenditures below the 2001 level of $276.5 million.
We expect our measure of full-year 2002 “cash flow” (net cash provided by operating activities reduced by expenditures for property additions) to be between the 2000 level of $650 million and the 2001 level of $856 million.
For the quarter ended June 29, 2002, the average number of diluted shares outstanding increased nearly 2% versus the prior-year period. Approximately one-half of this increase was attributable to a higher market price; thus, more “in-the-money” employee stock options outstanding, with the remainder resulting from actual option exercises. As a result of this increased dilution, we have decided to use available cash from employee stock option exercises to repurchase shares during the remainder of the year. These purchases will be made under an existing authorization by our Board of Directors, which allows us to repurchase up to $150 million of Kellogg common stock during 2002.
Despite the substantial amount of debt incurred to finance the Keebler acquisition, we believe we have made good progress in improving our financial flexibility since March 2001, reducing our total debt from $6.8 billion to the current-quarter level of $5.8 billion. We 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 through our strong cash flow, our program of issuing commercial paper, and maintaining credit facilities on a global basis.
Our significant long-term debt issues do not contain acceleration of maturity clauses that are dependent on credit ratings. A change in the Company’s credit ratings could limit its access to the U.S. commercial paper 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 credit facilities, which are in amounts sufficient to cover the outstanding commercial paper balance and debt principal repayments through 2003.
Recently issued pronouncements
In July 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal”, which is effective for exit or disposal activities initiated after December 31, 2002, with early application encouraged. We currently plan to adopt SFAS No. 146 for our 2003 fiscal year.
This Statement is intended to achieve consistency in timing of recognition between exit costs, such as one-time employee separation benefits and contract termination payments, and all other costs. Under existing literature, certain costs associated with exit activities are recognized when management commits to a plan. Under SFAS No. 146, costs will be recognized when a liability has been incurred under general concepts. For instance, under existing literature, plant closure costs would be accrued at the plan commitment date. Under SFAS No. 146, these costs would be recognized as closure activities are performed. These provisions could be expected to have the general effect of delaying recognition of certain costs related to restructuring programs. However, we do not currently expect adoption of this Standard to have a significant impact on our 2003 financial results.
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Forward-looking statements
Our Management’s Discussion and Analysis contains “forward-looking statements” with projections concerning, among other things, our strategy and plans; exit plans and costs related to the Keebler acquisition; the impact of accounting changes; our ability to meet interest and debt principal repayment obligations; future common stock repurchases; effective income tax rate; cash flow; property addition expenditures; cash outlays for restructuring actions; and interest expense. Forward-looking statements include predictions of future results or activities and may contain the words “expect,” “believe,” “will,” “will deliver,” “anticipate,” “project,” “should,” or words or phrases of similar meaning. Our actual results or activities may differ materially from these predictions. In particular, future results or activities could be affected by factors related to the Keebler acquisition, including integration problems, failures to achieve savings, unanticipated liabilities, and the substantial amount of debt incurred to finance the acquisition, which could, among other things, hinder our ability to adjust rapidly to changing market conditions, make us more vulnerable in the event of a downturn, and place us at a competitive disadvantage relative to less-leveraged competitors. In addition, our future results could be affected by a variety of other factors, including
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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PART II — OTHER INFORMATION
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 8, 2002
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EXHIBIT INDEX
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