Kellanova (Kellogg's) - 10-Q quarterly report FY

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

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 o

Common Stock outstanding October 31, 2002 – 408,250,199 shares

Table of Contents

KELLOGG COMPANY

INDEX

Table of Contents

Kellogg Company and Subsidiaries
CONSOLIDATED BALANCE SHEET
(millions, except per share data)

* Condensed from audited financial statements

Refer to Notes to Consolidated Financial Statements

2

Table of Contents

Kellogg Company and Subsidiaries
CONSOLIDATED EARNINGS
(millions, except per share data)

Refer to Notes to Consolidated Financial Statements

3

Table of Contents

Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
(millions)

Refer to Notes to Consolidated Financial Statements

4

Table of Contents

Notes to Consolidated Financial Statements
for the quarter and year-to-date period ended September 28, 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 September 28, 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 has been 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 were 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 8 for further information on the Company’s goodwill and other intangible assets.

5

Table of Contents

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

6

Table of Contents

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.

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 $29 million in 2002, with the remaining amounts spent principally during 2003.

Management’s exit plans are being announced as individual initiatives are implemented. In August 2002, the Company announced plans to consolidate certain functions in Battle Creek, Michigan, primarily research, technology, and financial services. As a result, approximately 70 positions in Elmhurst, Illinois are being relocated or eliminated.

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 year-to-date period ended September 28, 2002, the Company paid additional contingent purchase price of $2 million, bringing the total purchase price, including related acquisition costs, to approximately $35 million.

7

Table of Contents

Note 3 Restructuring and other charges

Cost of goods sold for the quarter ended September 28, 2002, includes a charge of $5.3 million related to the Company’s planned divestiture of certain private-label operations in Australia. The charge is comprised principally of an impairment loss to reduce the carrying value of production assets held for sale to estimated fair value less cost to sell.

Cost of goods sold for the year-to-date period ended September 28, 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 September 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 September 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 September 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 year-to-date period ended September 28, 2002, includes a $19.6 million credit, 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:

8

Table of Contents

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.

9

Table of Contents

10

Table of Contents

Accumulated other comprehensive income (loss) as of September 28, 2002 and December 31, 2001 consisted of the following:

Note 6 Debt
Subsequent to the Keebler acquisition in March 2001, the Company has repaid over one billion dollars of debt incurred for this purpose, which reduced its commercial paper program to approximately 2% of the total debt balance. During September 2002, the Company issued $400 million of U.S. commercial paper and redeemed $300.7 million of fixed rate Notes due April 2003. Interest expense for the quarter ended September 28, 2002, includes $5.9 million of accelerated interest related to this redemption.

Note 7 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.

11

Table of Contents

12

Table of Contents

Note 8 Supplemental information on goodwill and other intangible assets

Intangible assets subjet to amortization (a):

(a)  Prior year amounts presented in accordance with current period classification under SFAS No. 142 — refer to Note 1 for further information.

(b)  The estimated aggregate amortization expense for each of the 5 succeeding fiscal years is approximately 1.6 million per year.

Intangible assets not subject to amortization (a):

(a)  Prior year amounts presented in accordance with current period classification under SFAS No. 142 — refer to Note 1 for further information.

(b)  Total carrying amount is net of accumulated amortization through December 31, 2001.

Changes in the carrying amount of goodwill for the year-to-date period ended September 28, 2002 (a):

(a)  Total carrying amount is net of accumulated amortization through December 31, 2001.

(b)  Assembled workforce intangible no longer meets separability criteria under SFAS No. 142 and has been reclassified to goodwill effective January 1, 2002.

(c)  Other operating segments include Australia, Asia, and Canada.

13

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
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.

During the current quarter, our company continued its 2002 trend of 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:

14

Table of Contents