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 September 27, 2003
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 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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
Common Stock outstanding October 24, 2003 - 408,138,504 shares
-1-
KELLOGG COMPANY
INDEX
PART I - Financial Information Page
Item 1:
Consolidated Balance Sheet - September 27, 2003, and
December 28, 2002 2
Consolidated Statement of Earnings - quarters and year-to-date
periods ended September 27, 2003 and September 28, 2002 3
Consolidated Statement of Cash Flows - year-to-date
periods ended September 27, 2003 and September 28, 2002 4
Notes to Consolidated Financial Statements 5-12
Item 2:
Management's Discussion and Analysis of Financial Condition
and Results of Operations 13-19
Item 3:
Quantitative and Qualitative Disclosures about Market Risk 20
Item 4:
Controls and Procedures 20
PART II - Other Information
Item 6:
Exhibits and Reports on Form 8-K 21
Signatures 22
Exhibit Index 23
-2-
Kellogg Company and Subsidiaries
CONSOLIDATED BALANCE SHEET
(millions, except per share data)
=================================================================================================================
Sept. 27, December 28,
2003 2002
(unaudited) *
=================================================================================================================
Current assets
Cash and cash equivalents $341.9 $100.6
Accounts receivable, net 842.4 741.0
Inventories:
Raw materials and supplies 183.6 172.2
Finished goods and materials in process 401.4 431.0
Other current assets 283.2 318.6
- -----------------------------------------------------------------------------------------------------------------
Total current assets 2,052.5 1,763.4
Property, net of accumulated depreciation
of $3,337.0 and $3,012.4 2,716.4 2,840.2
Goodwill 3,102.6 3,106.6
Other intangibles, net of accumulated amortization
of $21.7 and $20.6 2,025.6 2,026.0
Other assets 491.5 483.1
- -----------------------------------------------------------------------------------------------------------------
Total assets $10,388.6 $10,219.3
=================================================================================================================
Current liabilities
Current maturities of long-term debt $577.8 $776.4
Notes payable 285.9 420.9
Accounts payable 623.6 619.0
Accrued advertising and promotion 371.2 309.0
Other current liabilities 956.1 889.6
- -----------------------------------------------------------------------------------------------------------------
Total current liabilities 2,814.6 3,014.9
Long-term debt 4,518.4 4,519.4
Deferred income taxes 1,000.4 986.4
Pension benefits 351.0 334.5
Nonpension postretirement benefits 337.8 329.6
Other liabilities 148.7 139.4
Shareholders' equity
Common stock, $.25 par value 103.8 103.8
Capital in excess of par value 25.3 49.9
Retained earnings 2,163.3 1,873.0
Treasury stock, at cost (254.1) (278.2)
Accumulated other comprehensive income (loss) (820.6) (853.4)
- -----------------------------------------------------------------------------------------------------------------
Total shareholders' equity 1,217.7 895.1
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $10,388.6 $10,219.3
=================================================================================================================
* Condensed from audited financial statements.
Refer to Notes to Consolidated Financial Statements.
-3-
Kellogg Company and Subsidiaries
CONSOLIDATED EARNINGS
(millions, except per share data)
======================================================================================================
Quarter Quarter Year-to-date Year-to-date
ended ended period ended period ended
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(Results are unaudited) 2003 2002 2003 2002
======================================================================================================
Net sales $2,281.6 $2,136.5 $6,676.5 $6,323.4
Cost of goods sold 1,247.6 1,163.4 3,710.8 3,502.1
Selling and administrative expense 603.2 558.3 1,773.4 1,707.0
------------------------------ -----------------------------
Operating profit 430.8 414.8 1,192.3 1,114.3
Interest expense 87.0 102.2 268.5 297.2
Other income (expense), net 7.6 8.1 2.2 24.5
------------------------------ -----------------------------
Earnings before income taxes 351.4 320.7 926.0 841.6
Income taxes 120.1 117.2 326.9 311.7
------------------------------ -----------------------------
Net earnings $231.3 $203.5 $599.1 $529.9
============================== =============================
Net earnings per share:
Basic $.57 $.50 $1.47 $1.30
Diluted $.56 $.49 $1.46 $1.29
Dividends per share $.2525 $.2525 $.7575 $.7575
============================== =============================
Average shares outstanding:
Basic 408.3 409.4 407.6 408.6
============================== =============================
Diluted 410.9 412.0 410.0 411.4
============================== =============================
Actual shares outstanding at period end 408.2 407.8
=============================
Refer to Notes to Consolidated Financial Statements.
-4-
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
(millions)
=========================================================================================
Year-to-date Year-to-date
period ended period ended
Sept. 27, Sept. 28,
(unaudited) 2003 2002
=========================================================================================
Operating activities
Net earnings $599.1 $529.9
Adjustments to reconcile net earnings to
operating cash flows:
Depreciation and amortization 272.0 260.4
Deferred income taxes 57.5 43.8
Other 59.9 45.0
Postretirement benefit plan contributions (59.9) (58.0)
Changes in operating assets and liabilities 54.4 249.4
- -----------------------------------------------------------------------------------------
Net cash provided by operating activities 983.0 1,070.5
- -----------------------------------------------------------------------------------------
Investing activities
Additions to properties (121.2) (136.0)
Acquisitions of businesses - (2.2)
Dispositions of businesses 14.0 61.0
Other 8.3 (1.9)
- -----------------------------------------------------------------------------------------
Net cash used in investing activities (98.9) (79.1)
- -----------------------------------------------------------------------------------------
Financing activities
Net issuances (reductions) of notes payable (135.0) (94.5)
Issuances of long-term debt 498.1 -
Reductions of long-term debt (710.9) (356.6)
Net issuances of common stock 80.4 91.4
Common stock repurchases (76.3) (82.8)
Cash dividends (308.8) (310.0)
- -----------------------------------------------------------------------------------------
Net cash used in financing activities (652.5) (752.5)
- -----------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 9.7 (9.5)
- -----------------------------------------------------------------------------------------
Increase in cash and cash equivalents 241.3 229.4
Cash and cash equivalents at beginning of period 100.6 231.8
- -----------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $341.9 $461.2
=========================================================================================
Refer to Notes to Consolidated Financial Statements.
-5-
Notes to Consolidated Financial Statements for the quarter
and year-to-date period ended September 27, 2003 (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 30 to 48 of the Company's 2002 Annual Report. The accounting policies used
in preparing these financial statements are the same as those summarized in the
Company's 2002 Annual Report, except as discussed below. Certain amounts for
2002 have been reclassified to conform to current-period classifications. The
results of operations for the quarter and year-to-date periods ended September
27, 2003, are not necessarily indicative of the results to be expected for other
interim periods or the full year.
Interim reporting periods
Beginning in 2002, the Company has reported interim periods on a thirteen-week
quarter basis, commonly referred to as "4-4-5" because of the number of weeks in
each sub-period of the quarter. Interim results for 2003 are being reported for
the periods ended March 29, June 28, September 27, and December 27. Interim
results for 2002 were reported for the periods ended March 30, June 29,
September 28, and December 28.
Accounting for exit costs
The Company has adopted SFAS No. 146 "Accounting for Costs Associated with Exit
or Disposal," with respect to exit or disposal activities initiated after
December 31, 2002. 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 pre-existing
literature, certain costs associated with exit activities were recognized when
management committed to a plan. Under SFAS No. 146, costs are recognized when a
liability has been incurred under general concepts. For instance, under
pre-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.
Guarantees
With respect to guarantees entered into or modified after December 31, 2002, the
Company has applied guidance contained in FASB Interpretation No. 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of indebtedness of Others." This interpretation clarifies
the requirement for recognition of a liability by a guarantor at the inception
of the guarantee, based on the fair value of the non-contingent obligation to
perform. Management does not currently expect application of this guidance to
have a significant impact on the Company's 2003 financial results.
Variable interest entities
During January 2003, the FASB issued Interpretation No. 46 "Consolidation of
Variable Interest Entities." Under previous practice, entities were included in
consolidated financial statements based on controlling voting interests. Under
this interpretation, previously unconsolidated entities (often referred to as
"special purpose entities") will be included in the consolidated financial
statements of the "primary beneficiary" as a result of non-voting financial
interests that are established through contractual or other means. For variable
interest entities created after January 31, 2003, this interpretation is
effective immediately. For any pre-existing variable interest entities, this
interpretation was originally effective beginning with the Company's fiscal 2003
third quarter. However, the FASB issued Staff Position 46-6 in October 2003,
which delays the effective date for pre-existing variable interest entities to
the Company's fiscal 2003 fourth quarter. Management does not currently believe
these requirements are applicable to any existing financial arrangement of the
Company.
-6-
Hedging activities
During April 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for derivative instruments and
hedging activities, resulting primarily from decisions reached by the FASB
Derivatives Implementation Group subsequent to the original issuance of SFAS No.
133. This Statement is generally effective prospectively for contracts and
hedging relationships entered into after June 30, 2003. Management currently
believes that adoption of SFAS No. 149 will have minimal impact on the Company,
except that cash flows associated with certain derivatives will be classified in
the financing rather than the operating section of the cash flow statement. Such
derivatives are generally limited to net investment hedges and those used by the
Company to reduce volatility in the translation of foreign currency earnings to
U.S. Dollars. Management believes the impact of this classification change
during 2003 will be insignificant.
Leasing
In May 2003, the Emerging Issues Task Force (EITF) of the FASB reached consensus
on Issue No. 01-8 "Determining Whether an Arrangement Contains a Lease." This
consensus provides criteria for identifying "in-substance" leases of plant,
property, and equipment within supply agreements, service contracts, and other
arrangements not historically accounted for as leases. This guidance is
generally applicable to arrangements entered into or modified in interim periods
beginning after May 28, 2003. The Company has applied this consensus
prospectively beginning in its fiscal third quarter of 2003. Management believes
this guidance may apply to certain future agreements with contract manufacturers
that produce or pack the Company's products, potentially resulting in capital
lease recognition within the balance sheet. However, management currently
believes the impact of this recognition during 2003 will be insignificant.
Stock compensation
The Company uses various equity-based compensation programs to provide long-term
performance incentives for its global workforce. Currently, these incentives
consist of stock options, performance units, restricted stock grants, and stock
purchase plans with various preferred terms. These awards are administered
through several plans, as described in Note 8 to Consolidated Financial
Statements on pages 40 and 41 of the Company's 2002 Annual Report.
The Company uses the intrinsic value method prescribed by Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," to account for
its employee stock options and other stock-based compensation. Under this
method, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of the grant, no
compensation expense is recognized. The table below presents pro forma results
for the current and prior-year periods, as if the Company had used the alternate
fair value method of accounting for stock-based compensation, prescribed by SFAS
No. 123 "Accounting for Stock-Based Compensation" (as amended by SFAS No. 148).
Under this pro forma method, the fair value of each option grant was estimated
at the date of grant using the Black-Scholes option-pricing model and was
recognized over the vesting period, generally two years. Pricing model
assumptions included an expected term of three years; and risk-free interest
rate, dividend yield, and volatility assumptions consistent with the expected
term and particular grant date.
-7-
- --------------------------------------------------------------------------------------------------------------
(millions except per share data) Quarter ended Year-to-date period ended
- --------------------------------------------------------------------------------------------------------------
September September September September
27, 2003 28, 2002 27, 2003 28, 2002
- --------------------------------------------------------------------------------------------------------------
Stock-based compensation expense, net of tax:
As reported $ 3.5 $ 2.7 $ 8.5 $ 8.0
Pro forma $ 10.6 $ 13.2 $ 30.4 $ 39.6
Net earnings:
As reported $ 231.3 $ 203.5 $ 599.1 $ 529.9
Pro forma $ 224.2 $ 193.0 $ 577.2 $ 498.3
Basic net earnings per share:
As reported $ 0.57 $ 0.50 $ 1.47 $ 1.30
Pro forma $ 0.55 $ 0.47 $ 1.42 $ 1.22
Diluted net earnings per share:
As reported $ 0.56 $ 0.49 $ 1.46 $ 1.29
Pro forma $ 0.55 $ 0.47 $ 1.41 $ 1.21
- --------------------------------------------------------------------------------------------------------------
Note 2 Exit activities
During the second half of 2003 and throughout 2004, management is undertaking a
series of productivity initiatives. Some of these initiatives are still in the
planning stages and individual actions are being announced as plans are
finalized. Major actions commenced to date include a wholesome snack plant
consolidation in Australia, manufacturing capacity rationalization in the
Mercosur region of Latin America, and plant workforce reduction in Great
Britain. Additionally, manufacturing and distribution network optimization
efforts in the Company's U.S. snacks business have been ongoing since the
Company's acquisition of Keebler in 2001.
The wholesome snack plant consolidation in Australia involves the exit of a
leased facility and separation of approximately 140 employees by year-end 2003.
Management expects to incur approximately $6 million in exit costs and asset
write-offs during the second half of 2003 related to this initiative.
The manufacturing capacity rationalization in the Mercosur region of Latin
America involves the closure of an owned facility in Argentina and separation of
approximately 95 plant and administrative employees by the end of 2003.
Beginning in 2004, the Company plans to import its products for sale in
Argentina from other Latin America facilities. The Company recorded an
impairment loss of approximately $6 million in the third quarter of 2003 to
reduce the carrying value of the manufacturing facility to estimated fair value,
and expects to incur further severance and closure costs of $3-$4 million to
complete this initiative.
In Great Britain, management is currently in negotiations regarding changes in
plant crewing to better match the work pattern to the demand cycle. This
initiative proposes to remove approximately 120 hourly and salaried employee
positions by year-end 2003, through voluntary severance and early retirement
programs. Management expects to incur approximately $14 million in separation
benefit costs to complete this initiative, the majority of which will be
recognized in the Company's fiscal fourth quarter of 2003.
Cost of goods sold for the quarter ended September 27, 2003 includes charges of
approximately $11 million for asset write-offs and exit costs associated with
all in-process productivity initiatives. The third quarter 2003 charges are
comprised of approximately $6 million for the impairment loss in Argentina, $3
million for equipment disposals in the Company's U.S. snacks business, and $2
million for asset write-offs and exit costs in Australia. For the year-to-date
period, cost of goods sold also includes charges of approximately $15 million,
attributable primarily to equipment disposals in the Company's U.S. snacks
business. Reserves for exit costs at September 27, 2003, were insignificant.
Cost of goods sold for the quarter ended September 28, 2002, included a charge
of $5.7 million related to the Company's planned divestiture of certain
private-label operations in Australia. The charge was 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. During December 2002, the
Company sold these assets for an amount in excess of the previously estimated
fair value, and recorded a credit to cost of goods sold of $2.3 million.
Cost of goods sold for the year-to-date period ended September 28, 2002,
included 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. The Company began marketing this facility for sale in early 2003, and is
currently in the final stages of a sales transaction for an amount that
approximates the carrying value.
-8-
Keebler
On March 26, 2001, the Company acquired Keebler Foods Company ("Keebler") in a
cash transaction valued at $4.56 billion. The final purchase price allocation
included $71.3 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, remaining reserves of $19.3 million
existed at year-end 2002, to be spent principally during 2003. Acquisition-date
exit plans were substantially completed during the first quarter of 2003, with
remaining reserves consisting primarily of contractual obligations for severance
and leases. During the year-to-date period ended September 27, 2003, $4.5
million of excess reserves were reversed. This excess resulted primarily from
lower than projected facility closure costs and employee severance payments,
and higher than projected proceeds from sale of leased vehicles and sub-lease
revenue.
- ------------------------------------------------------------------------------------------------------------------------------------
Employee Lease & other Facility
severance Employee contract closure
(millions) benefits relocation termination costs Total
- ------------------------------------------------------------------------------------------------------------------------------------
Remaining reserve at December 28, 2002 $ 7.2 $ 0.6 $ 9.6 $ 1.9 $ 19.3
2003 year-to-date activity:
Utilized (5.0) (0.1) (2.2) (0.4) (7.7)
Reversed (1.2) (0.4) (1.7) (1.2) (4.5)
- ------------------------------------------------------------------------------------------------------------------------------------
Remaining reserve at September 27, 2003 $ 1.0 $ 0.1 $ 5.7 $ 0.3 $ 7.1
- ------------------------------------------------------------------------------------------------------------------------------------
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. In January 2003, the Company sold additional private-label
operations for approximately $14 million in cash. For both of these
transactions, the carrying value of net assets sold, including allocated
goodwill, approximated the net sales proceeds.
Note 3 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
asset sales. Other income (expense), net for the year-to-date period ended
September 27, 2003, includes a credit of approximately $17 million related to
favorable legal settlements; a charge of $8 million for a contribution to the
Kellogg's Corporate Citizenship Fund, a private trust established for charitable
giving; and a charge of $6.5 million to recognize the impairment of a cost-basis
investment in an e-commerce business venture. Other income (expense), net for
the year-to-date period ended September 28, 2002, includes a $19.6 million
credit, related to favorable legal settlements. The aforementioned charges and
credits recognized in 2003 and 2002 were recognized largely during the first
quarter of both years.
Note 4 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:
-9-
- ------------------------------------------------------------------------------------------------------
Quarter Average Net
(millions, except Net shares earnings
per share data) earnings outstanding per share
- ------------------------------------------------------------------------------------------------------
2003
Basic $231.3 408.3 $.57
Dilutive employee
stock options - 2.6 (0.01)
- ------------------------------------------------------------------------------------------------------
Diluted $231.3 410.9 $.56
- ------------------------------------------------------------------------------------------------------
2002
Basic $203.5 409.4 $.50
Dilutive employee
stock options - 2.6 (0.01)
- ------------------------------------------------------------------------------------------------------
Diluted $203.5 412.0 $.49
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
Year-to-date Average Net
(millions, except Net shares earnings
per share data) earnings outstanding per share
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
2003
Basic $599.1 407.6 $1.47
Dilutive employee
stock options - 2.4 (0.01)
- ------------------------------------------------------------------------------------------------------
Diluted $599.1 410.0 $1.46
- ------------------------------------------------------------------------------------------------------
2002
Basic $529.9 408.6 $1.30
Dilutive employee
stock options - 2.8 (0.01)
- ------------------------------------------------------------------------------------------------------
Diluted $529.9 411.4 $1.29
- ------------------------------------------------------------------------------------------------------
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 pursuant to SFAS No. 87
"Employers' Accounting for Pensions."
-10-
- --------------------------------------------------------------------------------------------
Tax
Quarter Pre-tax (expense) or After-tax
(millions) amount benefit amount
- --------------------------------------------------------------------------------------------
2003
Net earnings $231.3
Other comprehensive income:
Foreign currency translation adjustments 2.0 - 2.0
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges 1.8 (0.7) 1.1
Reclassification to net earnings 1.3 (0.5) 0.8
Minimum pension liability adjustments - - -
- -------------------------------------------------------------------------------------------
5.1 (1.2) 3.9
- -------------------------------------------------------------------------------------------
Total comprehensive income $235.2
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
Tax
Pre-tax (expense) or After-tax
(millions) amount benefit amount
- -------------------------------------------------------------------------------------------
2002
Net earnings $203.5
Other comprehensive income:
Foreign currency translation adjustments 3.6 - 3.6
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges (0.1) 1.1 1.0
Reclassification to net earnings 1.6 (0.5) 1.1
Minimum pension liability adjustments - - -
- --------------------------------------------------------------------------------------------
5.1 0.6 5.7
- --------------------------------------------------------------------------------------------
Total comprehensive income $209.2
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
Tax
Year-to-date Pre-tax (expense) or After-tax
(millions) amount benefit amount
- --------------------------------------------------------------------------------------------
2003
Net earnings $599.1
Other comprehensive income:
Foreign currency translation adjustments 35.5 - 35.5
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges (14.2) 4.8 (9.4)
Reclassification to net earnings 10.5 (3.8) 6.7
Minimum pension liability adjustments - - -
- --------------------------------------------------------------------------------------------
31.8 1.0 32.8
- --------------------------------------------------------------------------------------------
Total comprehensive income $631.9
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
Tax
Pre-tax (expense) or After-tax
(millions) amount benefit amount
- --------------------------------------------------------------------------------------------
2002
Net earnings $529.9
Other comprehensive income:
Foreign currency translation adjustments (20.4) - (20.4)
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges 1.6 (0.3) 1.3
Reclassification to net earnings 6.2 (2.3) 3.9
Minimum pension liability adjustments - - -
- --------------------------------------------------------------------------------------------
(12.6) (2.6) (15.2)
- --------------------------------------------------------------------------------------------
Total comprehensive income $514.7
- --------------------------------------------------------------------------------------------
-11-
Accumulated other comprehensive income (loss) as of September 27, 2003, and
December 28, 2002, consisted of the following:
- -------------------------------------------------------------------------------
September 27, December 28,
(millions) 2003 2002
- -------------------------------------------------------------------------------
Foreign currency translation adjustments $ (452.1) $ (487.6)
Cash flow hedges -- unrealized net loss (49.0) (46.3)
Minimum pension liability adjustments (319.5) (319.5)
- -------------------------------------------------------------------------------
Total accumulated other comprehensive income (loss) $ (820.6) $ (853.4)
- -------------------------------------------------------------------------------
Note 5 Debt
On April 1, 2003, the Company repaid $699.3 million of maturing 5.50% U.S.
Dollar Notes and initially replaced this debt with U.S. short-term debt. On June
5, 2003, the Company issued $500 million of five-year 2.875% fixed rate U.S.
Dollar Notes, using the proceeds from these Notes to repay a portion of the U.S.
short-term debt. These Notes were issued under an existing shelf registration
statement. In conjunction with this issuance, the Company settled $250 million
notional amount of forward interest rate contracts for a loss of $11.8 million,
which is being amortized to interest expense over the term of the debt. Taking
into account this amortization and issuance discount, the effective interest
rate on these five-year Notes is 3.35%.
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 expense related to this redemption.
Note 6 Operating segments
Kellogg Company is the world's leading producer of cereal and a leading producer
of convenience foods such as cereal bars, frozen waffles, toaster pastries,
cookies, and crackers. The Company also produces natural and vegetarian foods.
Kellogg products are manufactured in 18 countries and marketed in more than 180
countries around the world. Principal markets for these products include the
United States and United Kingdom. In recent years, the Company has been 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.
=======================================================================================================
Year-to-date Year-to-date
Quarter ended Quarter ended period ended period ended
(millions) Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(Results are unaudited) 2003 2002 2003 2002
=======================================================================================================
Net sales
United States $1,442.5 $1,405.4 $4,294.6 $4,231.6
Europe 451.1 393.6 1,308.5 1,102.1
Latin America 176.1 160.5 482.1 480.6
All other operating segments 211.9 177.0 591.3 509.1
Corporate - - - -
------------------------------ ------------------------------
Consolidated $2,281.6 $2,136.5 $6,676.5 $6,323.4
============================== ==============================
- -------------------------------------------------------------------------------------------------------
Segment operating profit
United States $290.7 $282.6 $798.9 $787.6
Europe 86.8 76.8 227.6 189.5
Latin America 44.8 44.6 130.9 128.8
All other operating segments 38.6 27.7 111.3 68.7
Corporate (30.1) (16.9) (76.4) (60.3)
------------------------------ ------------------------------
Consolidated 430.8 414.8 1,192.3 1,114.3
============================== ==============================
-12-
During the third quarter of 2003, the Company announced several senior
management changes, which will result in some minor organizational changes to be
fully implemented by 2004. As a result, management anticipates that full-year
2003 and prior-year segment disclosures will be restated to reflect the
following operating segments: North America, Europe, Latin America, and
Australia/Asia.
Note 7 Supplemental information on goodwill and other intangible assets
- -------------------------------------------------------------------------------------------------------------------------------
Intangible assets subject to amortization:
(millions)
Gross carrying amount Accumulated amortization
-------------------------------- ----------------------------------
September 27, December 28, September 27, December 28,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
Trademarks $ 29.5 $ 29.5 $ 18.0 $ 17.2
Other 6.6 6.7 3.7 3.4
- -------------------------------------------------------------------------------------------------------------------------------
Total $ 36.1 $ 36.2 $ 21.7 $ 20.6
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Amortization expense (millions) (a): September 27, 2003 September 28, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Quarter ended $ 0.4 $ 0.4
- -------------------------------------------------------------------------------------------------------------------------------
Year-to-date $ 1.2 $ 1.2
- -------------------------------------------------------------------------------------------------------------------------------
(a) The currently 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:
(millions)
Total carrying amount
---------------------------------------------
September 27, 2003 December 28, 2002
- -----------------------------------------------------------------------------------------
Trademarks $ 1,404.0 $ 1,404.0
Direct store door (DSD) delivery system 578.9 578.9
Other 28.3 27.5
- -----------------------------------------------------------------------------------------
Total $ 2,011.2 $ 2,010.4
- -----------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Changes in the carrying amount of goodwill for the year-to-date period ended
September 27, 2003:
(millions)
Consoli-
United States Europe Latin America Other (b) dated
- -------------------------------------------------------------------------------------------------------------------------------
December 28, 2002 $ 3,103.2 $ - $ 2.0 $ 1.4 $ 3,106.6
Dispositions (4.9) - - - (4.9)
Foreign currency remeasurement impact and other - - 0.4 0.5 0.9
- -------------------------------------------------------------------------------------------------------------------------------
September 27, 2003 $ 3,098.3 $ - $ 2.4 $ 1.9 $ 3,102.6
- -------------------------------------------------------------------------------------------------------------------------------
(b) Other operating segments include Australia, Asia, and Canada.
-13-
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 such as cereal bars, frozen waffles, toaster pastries,
cookies, and crackers. The Company also produces natural and vegetarian foods.
Kellogg products are manufactured and marketed globally. In recent years, the
Company has been managed in two major divisions - the United States and
International - with International further delineated into Europe, Latin
America, Canada, Australia, and Asia. While this historical organizational
structure is the basis of the operating segment data presented in this report,
we are in the process of reorganizing our geographic management structure to
North America, Europe, Latin America, and Australia/Asia by 2004.
During the current quarter, our Company continued to demonstrate business
momentum with solid financial performance, achieving broad-based sales and
operating profit growth, despite substantial reinvestment in brand building and
productivity initiatives. For the quarter ended September 27, 2003, our Company
reported net earnings per share of $.56, a 14% increase over the prior-year
amount of $.49. For the year-to-date period, net earnings per share were $1.46
versus the prior period amount of $1.29. This year-over-year increase of $.17
was comprised of $.11 of business growth, $.02 from reduced interest expense,
$.04 from a lower effective income tax rate, and $.02 from favorable foreign
currency movements; partially offset by $.02 of favorable legal settlements in
the first quarter of 2002.
Net sales and operating profit
The following tables provide an analysis of net sales and operating profit
performance for the third quarter of 2003 versus 2002:
- -----------------------------------------------------------------------------------------------------------------------
(dollars in millions)
Other
United Latin operating Consoli-
States Europe America (b) Corporate dated
- -----------------------------------------------------------------------------------------------------------------------
2003 net sales $1,442.5 $ 451.1 $ 176.1 $ 211.9 $ - $2,281.6
- -----------------------------------------------------------------------------------------------------------------------
2002 net sales $1,405.4 $ 393.6 $ 160.5 $ 177.0 $ - $2,136.5
- -----------------------------------------------------------------------------------------------------------------------
% change - 2003 vs. 2002:
Volume -0.9% 1.5% 11.8% -1.5% - 0.5%
Pricing/mix 4.1% 2.3% 5.0% 6.0% - 4.0%
- -----------------------------------------------------------------------------------------------------------------------
Subtotal - internal business 3.2% 3.8% 16.8% 4.5% - 4.5%
Dispositions (a) -0.6% 0.0% 0.0% 0.0% - -0.4%
Foreign currency impact 0.0% 10.8% -7.1% 15.2% - 2.7%
- -----------------------------------------------------------------------------------------------------------------------
Total change 2.6% 14.6% 9.7% 19.7% - 6.8%
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
(dollars in millions)
Other
United Latin operating Consoli-
States Europe America (b) Corporate dated
- -----------------------------------------------------------------------------------------------------------------------
2003 operating profit $ 290.7 $ 86.8 $ 44.8 $ 38.6 $ (30.1) $ 430.8
- -----------------------------------------------------------------------------------------------------------------------
2002 operating profit $ 282.6 $ 76.8 $ 44.6 $ 27.7 $ (16.9) $ 414.8
- -----------------------------------------------------------------------------------------------------------------------
% change - 2003 vs. 2002:
Internal business 3.1% 3.4% 11.7% 22.3% -80.4% 2.2%
Dispositions (a) -0.2% 0.0% 0.0% 0.0% 0.0% -0.2%
Foreign currency impact 0.0% 9.7% -11.2% 17.6% 0.0% 1.8%
- -----------------------------------------------------------------------------------------------------------------------
Total change 2.9% 13.1% 0.5% 39.9% -80.4% 3.8%
- -----------------------------------------------------------------------------------------------------------------------
(a) Impact of results for the comparable 2002 periods prior to divestiture of
various U.S. private label operations. Refer to Note 2 within Notes to
Consolidated Financial Statements for further information.
(b) Includes Canada, Australia, and Asia.
-14-
During the third quarter of 2003, we achieved consolidated internal net sales
growth of 4.5%, against a strong year-ago growth rate of 5.6%. U.S. net sales in
the retail cereal channel increased approximately 11%, as the combination of
brand-building activities and innovation drove higher volume and improved mix. A
modest price increase taken early this year also contributed to the sales
increase. Excluding the impact of private-label business divestitures during the
past year, internal net sales of our U.S. snacks business, (which includes
cereal bars and other wholesome snacks, cookies, and crackers), declined
approximately 4%. Over three-quarters of this decline was attributable to two
factors: discontinuance of a low-margin contract manufacturing relationship in
May 2003 and an acceleration of stock-keeping unit (SKU) rationalization,
beginning in the second quarter of 2003. The remainder of the decline was
attributable primarily to softness in cookie sales, which we believe is a result
of aggressive price-promotion by competitors and a relative lack of innovation
and brand-building activities. While overshadowed during the present quarter, we
believe continued growth in crackers and wholesome snacks will approximately
offset these unfavorable factors, which are expected to persist into the fourth
quarter. Internal net sales for our other U.S. businesses, (which include frozen
waffles, toaster pastries, natural and vegetarian foods, and food-away-from-home
channels), collectively increased approximately 3%.
Total international net sales increased nearly 7% in local currencies, with
growth across all segments. Importantly, our European operating segment
continued to exhibit strong sales and category share performance in the quarter,
benefiting from increased brand-building investment and innovation activities
across the region. Internal net sales growth in Latin America was driven by a
strong performance by our Mexican business unit in both cereal and snacks. Our
other non-U.S. segments, which include Canada, Australia, and Asia, collectively
delivered solid internal net sales growth, as significant pricing/mix
improvements offset the volume impact of discontinuing product lines in
Australia and Asia in late 2002.
Consolidated internal operating profit increased 2% during the quarter, with
higher corporate expenses partially offsetting solid growth in both U.S. and
international operating profit. International operating profit increased over 9%
on a local currency basis. U.S. internal operating profit growth was 3%, despite
a double-digit increase in brand-building expenditures and the continuation of
higher commodity, energy, and employee benefit costs.
During the second half of 2003 and throughout 2004, we are undertaking a series
of productivity initiatives. Some of these initiatives are still in the planning
stages and individual actions are being announced as plans are finalized. Major
actions commenced to date include a wholesome snack plant consolidation in
Australia, manufacturing capacity rationalization in the Mercosur region of
Latin America, and plant workforce reduction in Great Britain. Additionally,
manufacturing and distribution network optimization efforts in our U.S. snacks
business have been ongoing since the Company's acquisition of Keebler in 2001.
(Refer to Note 2 within Notes to Consolidated Financial Statements for more
information on these initiatives.)
Cost of goods sold for the quarter ended September 27, 2003, includes charges of
approximately $11 million for asset write-offs and exit costs associated with
all in-process productivity initiatives. The third quarter 2003 charges were
comprised of approximately $6 million for an impairment loss in Argentina, $3
million for equipment disposals in our U.S. snacks business, and $2 million for
asset write-offs and exit costs in Australia. For the year-to-date period, cost
of goods sold also included charges of approximately $15 million, attributable
primarily to equipment disposals in our U.S. snacks business.
The productivity initiatives that we are undertaking could potentially result in
a yet-undetermined amount of exit costs and asset write-offs during the
remainder of 2003 and into 2004. Additionally, we expect to continue with
manufacturing network optimization efforts in our U.S. snacks business. These
initiatives, and others to be announced later, are all intended to position our
Company for sustained reliable growth in earnings and cash flow for the
long-term.
The following tables provide an analysis of net sales and operating profit
performance for the year-to-date periods of 2003 versus 2002:
-15-
- -----------------------------------------------------------------------------------------------------------------------
(dollars in millions)
Other
United Latin operating Consoli-
States Europe America (b) Corporate dated
- -----------------------------------------------------------------------------------------------------------------------
2003 net sales $4,294.6 $1,308.5 $ 482.1 $ 591.3 $ - $6,676.5
- -----------------------------------------------------------------------------------------------------------------------
2002 net sales $4,231.6 $1,102.1 $ 480.6 $ 509.1 $ - $6,323.4
- -----------------------------------------------------------------------------------------------------------------------
% change - 2003 vs. 2002:
Volume -0.4% -0.5% 6.4% -4.1% - -0.2%
Pricing/mix 3.2% 4.1% 6.4% 7.7% - 4.0%
- -----------------------------------------------------------------------------------------------------------------------
Subtotal - internal business 2.8% 3.6% 12.8% 3.6% - 3.8%
Dispositions (a) -1.3% 0.0% 0.0% 0.0% - -0.9%
Foreign currency impact 0.0% 15.1% -12.5% 12.5% - 2.7%
- -----------------------------------------------------------------------------------------------------------------------
Total change 1.5% 18.7% 0.3% 16.1% - 5.6%
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
(dollars in millions)
Other
United Latin operating Consoli-
States Europe America (b) Corporate dated
- -----------------------------------------------------------------------------------------------------------------------
2003 operating profit $ 798.9 $ 227.6 $ 130.9 $ 111.3 $ (76.4) $1,192.3
- -----------------------------------------------------------------------------------------------------------------------
2002 operating profit $ 787.6 $ 189.5 $ 128.8 $ 68.7 $ (60.3) $1,114.3
- -----------------------------------------------------------------------------------------------------------------------
% change - 2003 vs. 2002:
Internal business 2.6% 6.3% 15.5% 44.6% -26.9% 6.0%
Dispositions (a) -1.2% 0.0% 0.0% 0.0% 0.0% -0.9%
Foreign currency impact 0.0% 13.8% -13.9% 17.5% 0.0% 1.9%
- -----------------------------------------------------------------------------------------------------------------------
Total change 1.4% 20.1% 1.6% 62.1% -26.9% 7.0%
- -----------------------------------------------------------------------------------------------------------------------
(a) Impact of results for the comparable 2002 periods prior to divestiture of
various U.S. private label operations.
(b) Includes Canada, Australia, and Asia.
Margin performance
Margin performance for the third quarter and year-to-date periods of 2003 versus
2002 are presented in the following tables:
- ----------------------------------------------------------------------
Quarter Change vs.
prior year
(pts.)
- ----------------------------------------------------------------------
2003 2002
- ----------------------------------------------------------------------
Gross margin 45.3% 45.5% -0.2
- ----------------------------------------------------------------------
SGA% (a) 26.4% 26.1% -0.3
- ----------------------------------------------------------------------
Operating margin 18.9% 19.4% -0.5
- ----------------------------------------------------------------------
- ----------------------------------------------------------------------
Year-to-date Change vs.
prior year
(pts.)
- ----------------------------------------------------------------------
2003 2002
- ----------------------------------------------------------------------
Gross margin 44.4% 44.6% -0.2
- ----------------------------------------------------------------------
SGA% (a) 26.5% 27.0% 0.5
- ----------------------------------------------------------------------
Operating margin 17.9% 17.6% 0.3
- ----------------------------------------------------------------------
(a) Selling, general, and administrative expense as a percentage of net sales.
-16-
The consolidated gross margin in both the quarter and year-to-date periods was
unfavorably impacted by asset write-offs and exit costs related to productivity
initiatives; and higher commodity, energy, and employee benefit costs. These
unfavorable factors were nearly offset by the favorable impact of operating
leverage, pricing and mix improvements, and savings from supply chain
productivity initiatives, resulting in only a 20 basis point decline in gross
margin versus the prior periods. As we increase our investment in productivity
initiatives during the remainder of the year, recognition of upfront costs
associated with these initiatives could limit gross margin expansion, resulting
in a full-year gross margin in line with the year-to-date results.
The decline in gross margin during the year-to-date period was more than offset
by a reduction in SGA%, attributable principally to lower overhead expenses.
Solid expansion of our operating margin was achieved despite an increase in
consolidated brand-building expenditures that exceeded the rate of sales growth.
Interest expense
We currently expect total year 2003 interest expense to be slightly less than
$360 million, down from the total year 2002 amount of $391.2 million, due
primarily to continuing pay-down of our debt balances. Gross interest expense,
prior to amounts capitalized to construction projects, was not significantly
different from reported interest expense in either the current or prior-year
periods. For 2004, we expect interest expense to be approximately $330 million.
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
asset sales. Other income (expense), net for the year-to-date period ended
September 27, 2003, includes a credit of approximately $17 million related to
favorable legal settlements; a charge of $8 million for a contribution to the
Kellogg's Corporate Citizenship Fund, a private trust established for charitable
giving; and a charge of $6.5 million to recognize the impairment of a cost-basis
investment in an e-commerce business venture. Other income (expense), net for
the year-to-date period ended September 28, 2002, includes a $19.6 million
credit, related to favorable legal settlements. These charges and credits for
both 2003 and 2002 were recognized largely during the first quarter of both
years.
Income taxes
During the third quarter of 2003, we reduced our full-year 2003 expectation for
the consolidated effective income tax rate from 36% to 35.3%. This is down from
the total year 2002 rate of 37%, due primarily to the implementation of various
tax planning initiatives, audit closures, and further integration of Kellogg and
Keebler operations. The year-to-date 2003 consolidated effective tax rate of
35.3% is consistent with our outlook for the 2004 rate of approximately 35.5%.
Liquidity and capital resources
Our principal source of liquidity is operating cash flows resulting from net
earnings, supplemented by borrowings for major acquisitions and other
significant transactions. This cash-generating capability is one of our
fundamental strengths and provides us with substantial financial flexibility in
meeting operating and investing needs.
Our measure of year-to-date 2003 cash flow (defined as net cash provided by
operating activities reduced by expenditures for property additions) was $861.8
million compared to $934.5 million in the prior-year period. We use this measure
of cash flow to focus management and investors on the amount of cash available
for debt repayment, dividend distributions, acquisition opportunities, and share
repurchase. Our cash flow metric is reconciled to GAAP-basis operating cash flow
as follows:
- -------------------------------------------------------------------------------------
(millions)
Year-to-date period ended
--------------------------------------
September 27, September 28,
2003 2002
- -------------------------------------------------------------------------------------
Net cash provided by operating activities $ 983.0 $ 1,070.5
Additions to properties (121.2) (136.0)
- -------------------------------------------------------------------------------------
Cash flow $ 861.8 $ 934.5
- -------------------------------------------------------------------------------------
-17-
Year-to-date 2003 cash flow was lower than the prior-year period, due primarily
to a difficult working capital comparison to the first quarter of 2002, as well
as timing of tax payments. Although lower than the prior-year period, our
year-to-date 2003 cash flow has actually exceeded our full-year target. Our
strong cash flow provides us with the flexibility for incremental voluntary
benefit plan contributions or debt reduction during the remainder of the year.
(The 2003 target compares to 2002 cash flow of $746.4 million, which was net of
the after-tax impact of year-end 2002 voluntary benefit plan contributions of
approximately $254 million.)
The third quarter of 2003 marked the ninth consecutive quarter in which our
Company has achieved sequential improvement in the management of core working
capital (inventory and trade receivables less trade payables). For the twelve
months ended September 27, 2003, core working capital as a percentage of sales
was 8.4%, as compared to 9.0% for the year-ago period and 8.8% for full-year
2002.
Our Board of Directors has authorized management to repurchase up to $250
million of stock during 2003, generally to offset or partially offset issuances
under employee benefit programs. Under this authorization, we paid approximately
$76 million during the year-to-date period ended September 27, 2003, to
repurchase approximately 2.5 million shares. On a full-year basis, we expect to
fund this repurchase program principally by proceeds from employee stock option
exercises.
On April 1, 2003, we repaid $699.3 million of maturing 5.50% U.S. Dollar Notes
and initially replaced this debt with U.S. short-term debt. On June 5, 2003, we
issued $500 million of five-year 2.875% fixed rate U.S. Dollar Notes, using the
proceeds from these Notes to repay a portion of the U.S. short-term debt. These
Notes were issued under an existing shelf registration statement. In conjunction
with this issuance, we settled $250 million notional amount of forward interest
rate contracts for a loss of $11.8 million, which is being amortized to interest
expense over the term of the debt. Taking into account this amortization and
issuance discount, the effective interest rate on these five-year Notes is
3.35%.
During 2002, several of our pension plans experienced shortfalls in market
values of trust assets versus the accounting measurement of accumulated
obligation. As a result of this condition, we were required to record on our
year-end 2002 balance sheet a reduction in equity of approximately $306 million.
Depending on interest rate movements and other factors, we could be required to
record another reduction in equity of a yet-undetermined amount at year-end
2003. These balance sheet adjustments will not affect our earnings and we do not
expect them to impact our liquidity, capital resources, or our ability to meet
current debt covenants and maintain credit ratings.
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 short-term debt, 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. short-term debt market and/or
increase the cost of refinancing long-term debt in the future. However, even
under these circumstances, we would continue to have access to our credit
facilities, which are in amounts sufficient to cover the outstanding short-term
debt balance and debt principal repayments through 2004.
Recently issued pronouncements
During April 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for derivative instruments and
hedging activities, resulting primarily from decisions reached by the FASB
Derivatives Implementation Group subsequent to the original issuance of SFAS No.
133. This Statement is generally effective prospectively for contracts and
hedging relationships entered into after June 30, 2003. We currently believe
that adoption of SFAS No. 149 will have minimal impact on the Company, except
that cash flows associated with certain derivatives will be classified in the
financing rather than the operating section of the cash flow statement. Such
derivatives are generally limited to net investment hedges and those used by the
Company to reduce volatility in the translation of foreign currency earnings to
U.S. Dollars. We believe that the impact of this classification change during
2003 will be insignificant.
-18-
In May 2003, the Emerging Issues Task Force (EITF) of the FASB reached consensus
on Issue No. 01-8 "Determining Whether an Arrangement Contains a Lease." This
consensus provides criteria for identifying "in-substance" leases of plant,
property, and equipment within supply agreements, service contracts, and other
arrangements not historically accounted for as leases. This guidance is
generally applicable to arrangements entered into or modified in interim periods
beginning after May 28, 2003. We have applied this consensus prospectively
beginning in our fiscal third quarter of 2003. We believe this guidance may
apply to certain future agreements with contract manufacturers that produce or
pack our Company's products, potentially resulting in capital lease recognition
within the balance sheet. However, we currently believe the impact of this
recognition during 2003 will be insignificant.
Future outlook
During the remainder of 2003 and 2004, our Company will continue to face several
important challenges, including
- - higher employee benefits expense;
- - significant increases in the prices of certain grains, cocoa, other
ingredients, packaging, and energy;
- - increased cost and reduced availability of certain types of insurance;
- - economic volatility in Latin America; and
- - a fundamental change in strategy for our snacks business, from an
"acquire-and-integrate" approach to one of sustainable, organic growth.
During the remainder of 2003, we believe these cost increases and risks can
continue to be largely offset with pricing and mix improvements, savings from
implemented productivity improvements, and sustained momentum in operating
performance and cash flow expansion. As a result, we currently believe we will
achieve full-year 2003 net earnings per share of $1.89-$1.91, as compared to
2002 net earnings per share of $1.75, which included $.02 from favorable legal
settlements in the first quarter.
Our long-term annual growth targets are low single-digit for sales, mid
single-digit for operating profit, and high single-digit for net earnings per
share. In general, we expect 2004 results to be consistent with these targets.
In addition to the continuing challenges listed above, the following important
trends and uncertainties should be noted:
- - Our 2004 fiscal year will include a 53rd week, which could add
approximately one percentage point of extra growth to our sales results.
- - We expect another year of sales decline for the cookie portion of our U.S.
snacks business, due principally to category factors, aggressive sku
eliminations, and discontinuance of a custom manufacturing business during
2003.
- - We expect to continue to incur asset write-offs and exit costs associated
with productivity initiatives throughout 2004.
- - We expect full-year growth in brand-building expenditures to exceed the
rate of sales growth.
Forward-looking statements
Our Management's Discussion and Analysis contain "forward-looking statements"
with projections concerning, among other things, our strategy and plans;
improvements and growth; sales, gross margins, brand building, operating profit,
and earnings per share; exit plans and costs related to productivity
initiatives; the impact of accounting changes; our ability to meet interest and
debt principal repayment obligations; future common stock repurchases or debt
reduction; effective income tax rate; cash flow and core working capital
improvements; interest expense; commodity and energy prices; and employee
benefit plan costs and funding. Forward-looking statements include predictions
of future results or activities and may contain the words "expect," "believe,"
"will," "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
-19-
- - the impact of competitive conditions;
- - the effectiveness of pricing, advertising, and promotional programs;
- - the success of innovation and new product introductions;
- - the recoverability of the carrying value of goodwill and other intangibles;
- - the success of productivity improvements and business transitions;
- - commodity and energy prices, and labor costs;
- - the availability of and interest rates on short-term financing;
- - actual market performance of benefit plan trust investments;
- - the levels of spending on systems initiatives, properties, business
opportunities, integration of acquired businesses, and other general and
administrative costs;
- - changes in consumer behavior and preferences;
- - the effect of U.S. and foreign economic conditions on items such as
interest rates, statutory tax rates, currency conversion and availability;
- - legal and regulatory factors; and,
- - business disruption or other losses from war, terrorist acts, or political
unrest.
Forward-looking statements speak only as of the date they were made, and we
undertake no obligation to publicly update them.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Refer to disclosures contained on pages 50-52 of the Company's 2002 Annual
Report.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer as appropriate, to allow timely decisions
regarding required disclosure based on management's interpretation of the
definition of "disclosure controls and procedures," in Rules 13a-15(e) and
15d-15(e). In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable, rather than absolute,
assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As of September 27, 2003, management carried out an evaluation under the
supervision and with the participation of the Company's Chief Executive Officer
and the Company's Chief Financial Officer, of the effectiveness of the design
and operation of the Company's disclosure controls and procedures. Based on the
foregoing, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective
at a reasonable level of assurance.
During the last fiscal quarter, there have been no changes in the Company's
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
-20-
KELLOGG COMPANY
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 - Employment Agreement with David Mackay
10.2 - Employment Agreement with Alan Harris
10.3 - Termination Agreement with Janet Kelly
31.1 - Rule 13a-14(e)/15d-14(a) Certification from Carlos M. Gutierrez
31.2 - Rule 13a-14(e)/15d-14(a) Certification from John A. Bryant
32.1 - Section 1350 Certification from Carlos M. Gutierrez
32.2 - Section 1350 Certification from John A. Bryant
(b) Reports on Form 8-K:
The Company filed Reports on Form 8-K for its second quarter results
dated July 28, 2003 and for its third quarter results dated November 3,
2003, in which it furnished a press release announcing those results
under items 9 and 12 of such Reports.
-21-
KELLOGG COMPANY
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.
KELLOGG COMPANY
/s/ J. A. Bryant
-------------------------------
J. A. Bryant
Principal Financial Officer;
Executive Vice President - Chief Financial Officer
/s/ J. M. Boromisa
-------------------------------
J. M. Boromisa
Principal Accounting Officer;
Senior Vice President - Corporate Controller
Date: November 7, 2003
-22-
KELLOGG COMPANY
EXHIBIT INDEX
Electronic (E)
Paper (P)
Incorp. By
Exhibit No. Description Ref. (IBRF)
10.1 Employment Agreement with David Mackay E
10.2 Employment Agreement with Alan Harris E
10.3 Termination Agreement with Janet Kelly E
31.1 Rule 13a-14(e)/15d-14(a) Certification from
Carlos M. Gutierrez E
31.2 Rule 13a-14(e)/15d-14(a) Certification from
John A. Bryant E
32.1 Section 1350 Certification from Carlos M. Gutierrez E
32.2 Section 1350 Certification from John A. Bryant E
-23-