EXHIBIT 13.01
MANAGEMENT'S DISCUSSION AND ANALYSIS
Kellogg Company and Subsidiaries
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, and meat alternatives. Kellogg
products are manufactured and marketed globally. In recent years, our
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 recently reorganized our geographic management structure to
North America, Europe, Latin America, and Asia Pacific, and we will begin
reporting on this basis for 2004.
Our strategy is to manage our Company for steady, consistent growth and an
attractive dividend yield, which together should provide strong total
return for shareholders. We achieve this sustainability through a focused
strategy to grow our cereal business, expand our snacks business, and
pursue selective growth opportunities. We support our business strategy
with a financial model that emphasizes sales dollars over shipment volume
(Volume to Value), as well as cash flow and return on invested capital
(Manage for Cash). We believe the success of our strategy and financial
principles are reflected in the steady improvement of our Company's
financial results over the past three years.
During 2001, our Company experienced a significant transition related to
the acquisition and first phase of the integration of Keebler Foods Company
(the "Keebler acquisition"), as well as the fundamental refocus of our
business model. While net earnings were dampened by increased interest and
tax expense, and other short-term financial impacts of this transition, we
achieved several important goals during 2001: increased dollar share in the
U.S. cereal category; pricing and mix-related improvements in net sales;
expansion of gross profit margin; and the highest cash flow (net cash
provided from operating activities less expenditures for property
additions) to that date in our Company's history.
In 2002, our Company accelerated its performance in several key metrics:
internal sales growth, expansion of gross profit margin, and continued
strong cash flow. We believe improved execution, increased brand-building
investment, better innovation, and a focus on value over volume were
important drivers of this performance.
In 2003, 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 year ended December 27, 2003, our Company reported net earnings per
diluted share of $1.92, a 10% increase over prior-year results. For the
year ended December 28, 2002, our Company reported net earnings per diluted
share of $1.75 versus $1.16 in 2001. Results for 2001 were reduced by
several charges and expense items, as presented in the table below.
2001 EXPENSE ITEMS AFFECTING COMPARABILITY WITH 2002 RESULTS
Per share (basic
(millions except per share data) Net earnings and diluted)
- ------------------------------------------------------------------------------
Debt extinguishment charge (a) $ 7.4 $ .02
Restructuring charges, net of credits (b) 20.5 .05
Keebler integration impact (c) 46.2 .11
Amortization eliminated by SFAS No. 142 (d) 85.0 .21
Cumulative effect of accounting change (e) 1.0 -
==============================================================================
(a) Net earnings for 2001 include a debt extinguishment charge of $7.4
(net of tax benefit of $4.2), which was originally classified as an
extraordinary loss. Under SFAS No. 145, which we adopted in 2003,
generally, debt extinguishments are no longer classified as
extraordinary items. Accordingly, the extraordinary loss for 2001 has
been reclassified to Earnings before cumulative effect of accounting
change.
(b) Operating profit for 2001 includes restructuring charges related to
implementing our operating principles and preparing Kellogg for the
Keebler integration. Refer to Note 3 within Notes to Consolidated
Financial Statements for further information.
(c) Sales and operating profit for 2001 were reduced by the financial
impact of Keebler integration activities. Refer to the discussion of
2002 and 2001 results on page 24 for further information.
(d) Under SFAS No. 142, which we adopted in 2002, virtually all of our
intangibles amortization expense was eliminated in post-2001 fiscal
years. Refer to Notes 1 and 15 within Notes to Consolidated Financial
Statements for further information.
(e) Net earnings for 2001 include a charge for the cumulative effect of
accounting change related to the adoption of SFAS No. 133 "Accounting
for Derivative Instruments and Hedging Activities." Refer to Note 1
within Notes to Consolidated Financial Statements for further
information.
NET SALES AND OPERATING PROFIT
2003 COMPARED TO 2002
The following tables provide an analysis of net sales and operating profit
performance for 2003 versus 2002:
Other
United Latin operating Consoli-
(dollars in millions) States Europe America (b) Corporate dated
- ------------------------------------------------------------------------------------------------------
2003 NET SALES $ 5,629.3 $ 1,734.2 $ 645.7 $ 802.3 $ - $ 8,811.5
2002 NET SALES $ 5,525.4 $ 1,469.8 $ 631.1 $ 677.8 $ - $ 8,304.1
- ------------------------------------------------------------------------------------------------------
% change - 2003 vs. 2002:
Volume (tonnage) -.2% -.6% 6.6% -3.4% - -
Pricing/mix 3.2% 3.4% 6.7% 7.1% - 3.8%
- ------------------------------------------------------------------------------------------------------
SUBTOTAL - INTERNAL BUSINESS 3.0% 2.8% 13.3% 3.7% - 3.8%
Dispositions (a) -1.1% - - - - -.8%
Foreign currency impact - 15.2% -11.0% 14.7% - 3.1%
- ------------------------------------------------------------------------------------------------------
TOTAL CHANGE 1.9% 18.0% 2.3% 18.4% - 6.1%
======================================================================================================
Other
United Latin operating Consoli-
(dollars in millions) States Europe America (b) Corporate dated
- ----------------------------------------------------------------------------------------------------
2003 OPERATING PROFIT $1,055.0 $ 279.8 $ 168.5 $ 140.0 ($ 99.2) $1,544.1
2002 OPERATING PROFIT $1,073.0 $ 252.5 $ 170.1 $ 104.0 ($ 91.5) $1,508.1
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% change - 2003 vs. 2002:
INTERNAL BUSINESS -.8% -2.1% 11.4% 18.5% -8.5% 1.1%
Dispositions (a) -.9% - - - - -.6%
Foreign currency impact - 12.9% -12.3% 16.2% - 1.9%
- ----------------------------------------------------------------------------------------------------
TOTAL CHANGE -1.7% 10.8% -.9% 34.7% -8.5% 2.4%
====================================================================================================
(a) Impact of results for the comparable 2002 periods prior to divestiture of
the Bake-Line private label business in April 2002 and additional private
label operations in January 2003. Refer to Note 2 within Notes to
Consolidated Financial Statements for further information.
(b) Includes Canada, Australia, and Asia.
Earning
Our
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During 2003, we achieved consolidated internal net sales growth of 3.8%,
against a strong year-ago growth rate of 4.0%. U.S. net sales in the retail
cereal channel increased approximately 7%, as the combination of
brand-building activities and innovation drove higher tonnage and improved
mix. A modest U.S. cereal price increase taken early in 2003 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) were approximately even with the prior year. The
2003 sales performance of our U.S. snacks business was negatively impacted
by our strategic decisions to discontinue a low-margin contract
manufacturing relationship in May 2003 and to accelerate stock-keeping unit
(SKU) rationalization, beginning in the second quarter of 2003. In addition
to these strategic factors, our U.S. snacks business experienced a decline
in cookie sales, which we believe is a result of aggressive price promotion
by competitors, a relative lack of innovation and brand-building
activities, and current trends in consumer preferences. While overshadowed
during 2003, we believe continued growth in wholesome snacks and stable
performance in crackers should offset persisting softness in cookie sales
during 2004. 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 over 5% in local currencies, with
growth in all geographic segments. Our European operating segment exhibited
strong sales and category share performance throughout 2003, 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 and mix improvements offset the tonnage impact of discontinuing
product lines in Australia and Asia in late 2002.
Consolidated internal operating profit increased only 1% during 2003, as
significant charges related to cost-saving initiatives partially offset
solid underlying business growth. U.S. internal operating profit declined
nearly 1%, absorbing the majority of the charges, as well as higher
commodity, energy, and employee benefit costs. International operating
profit increased over 6% on a local currency basis. Brand-building
expenditures increased significantly in all core markets, reaching a
double-digit growth rate on a consolidated basis.
During 2003, we recorded in selling, general, and administrative expense an
impairment loss of $10 million to reduce the carrying value of a
contract-based intangible asset. The asset is associated with a long-term
licensing agreement principally in the United States and the decline in
value was based on the proportionate decline in estimated future cash flows
to be derived from the contract versus original projections.
To position our Company for sustained, reliable growth in earnings and cash
flow for the long term, we are undertaking a series of cost-saving
initiatives. Some of these initiatives are still in the planning stages and
individual actions are being announced as plans are finalized. Major
actions implemented in 2003 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. Taking into account all of these major
initiatives, plus other various plant productivity and overhead reduction
projects, the Company recorded total charges of approximately $71 million
during 2003, comprised of $40 million in asset write-offs, $8 million for
pension settlements, and $23 million in severance and other cash exit
costs. These charges were recorded principally in cost of goods sold and
impacted the Company's operating segments as follows (in millions):
U.S.-$36, Europe-$21, Latin America-$8, all other-$6. (Refer to Note 3
within Notes to Consolidated Financial Statements for further information
on these initiatives.)
The cost-saving initiatives that we are undertaking could potentially
result in a yet-undetermined amount of exit costs and asset write-offs
during 2004. Additionally, we expect to continue with manufacturing network
optimization efforts in our U.S. snacks business.
2002 COMPARED TO 2001
The following tables provide an analysis of net sales and operating profit
performance for 2002 versus 2001:
Other
United Latin operating Consoli-
(dollars in millions) States Europe America (e) Corporate dated
- ----------------------------------------------------------------------------------------------------------
2002 NET SALES $5,525.4 $1,469.8 $ 631.1 $ 677.8 $ - $8,304.1
2001 NET SALES $4,889.4 $1,360.7 $ 650.0 $ 648.3 $ - $7,548.4
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% change - 2002 vs. 2001:
Volume (tonnage) .3% - .1% -3.2% - -.2%
Pricing/mix 3.8% 2.4% 6.6% 5.6% - 4.2%
- ----------------------------------------------------------------------------------------------------------
SUBTOTAL - INTERNAL BUSINESS 4.1% 2.4% 6.7% 2.4% - 4.0%
Integration impact (a) .4% - - - - .2%
Acquisitions & dispositions (b) 8.5% - - - - 5.5%
Foreign currency impact - 5.6% -9.6% 2.2% - .3%
- ----------------------------------------------------------------------------------------------------------
TOTAL CHANGE 13.0% 8.0% -2.9% 4.6% - 10.0%
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Kellogg
Company
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Other
United Latin operating Consoli-
(dollars in millions) States Europe America (e) Corporate dated
- --------------------------------------------------------------------------------------------------------------
2002 SEGMENT OPERATING PROFIT $1,073.0 $ 252.5 $ 170.1 $ 104.0 ($ 91.5) $1,508.1
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2001 operating profit $ 745.5 $ 245.8 $ 170.7 $ 101.6 ($ 95.7) $1,167.9
Restructuring charges (c) 29.5 (.2) (.1) 1.4 2.7 33.3
Amortization (d) 100.5 - .5 .1 2.5 103.6
- --------------------------------------------------------------------------------------------------------------
2001 SEGMENT OPERATING PROFIT $ 875.5 $ 245.6 $ 171.1 $ 103.1 ($ 90.5) $1,304.8
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% change - 2002 vs. 2001:
INTERNAL BUSINESS 10.6% -3.1% 4.9% -1.4% -10.5% 6.4%
Integration impact (a) 8.7% - - - 9.4% 6.3%
Acquisitions & dispositions (b) 3.3% - - - - 2.3%
Foreign currency impact - 5.9% -5.5% 2.2% -.1% .6%
- --------------------------------------------------------------------------------------------------------------
TOTAL CHANGE 22.6% 2.8% -.6% .8% -1.2% 15.6%
==============================================================================================================
(a) Impact of Keebler integration activities during 2001. Refer to
discussion of results of operations in paragraphs following these
tables for further information.
(b) Impact of results for the first twelve weeks of 2002 from Keebler
Foods Company, acquired in March 2001; and impact of results for the
comparable 2001 period subsequent to the April 2002 divestiture of the
Bake-Line private label business. Refer to Note 2 within Notes to
Consolidated Financial Statements for further information.
(c) Operating profit for 2001 included restructuring charges related to
implementing our operating principles and preparing Kellogg for the
Keebler integration. Refer to Note 3 within Notes to Consolidated
Financial Statements for further information.
(d) Pro forma impact of amortization eliminated by SFAS No. 142. Refer to
Note 1 within Notes to Consolidated Financial Statements for further
information.
(e) Includes Canada, Australia, and Asia.
During 2002, we achieved strong internal sales growth of 4% on a
consolidated basis, resulting primarily from pricing and mix improvements
in all operating segments. U.S. net sales in the retail cereal business
increased approximately 6% and total international sales increased over 3%
in local currencies. Excluding the impact of acquisitions, divestitures,
and Keebler integration activities, internal net sales in the U.S. retail
snacks business were approximately even with the prior year, as a
double-digit increase in sales of our wholesome snack products offset a
decline in cookie and cracker sales. We believe this decline was primarily
as a result of weak consumption in the cookie and cracker categories
throughout the year and our decision to cancel an end-of-year sales force
incentive in order to improve efficiencies in our direct store door (DSD)
delivery system.
During 2002, consolidated and U.S. internal operating profit increased
approximately 6% and 11%, respectively. Total international local currency
operating profit was approximately even with the prior year, held down by a
double-digit increase in marketing investment to drive core market sales
growth.
Cost of goods sold for 2002 includes an impairment loss of $5 million
related to our 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 completed a sale of this
facility in late 2003, and the carrying value of the property approximated
the net sales proceeds.
During 2001, sales and operating profit were reduced by the financial
impact of Keebler integration activities ("integration impact"). This
integration impact consisted primarily of 1) the sales and gross profit
effect of lowering trade inventories to transfer our snack foods to
Keebler's DSD system during the second quarter, 2) direct costs for
employee incentive and retention programs, employee separation and
relocation benefits, and consulting contracts, and 3) impairment and
accelerated depreciation of software assets being abandoned due to the
conversion of our U.S. business to the SAP system. We estimate that these
activities reduced net sales by $17.8 million, increased cost of goods sold
by $5.6 million, and increased selling, general, and administrative expense
by $51.0 million, for a total 2001 operating profit reduction of $74.4
million.
MARGIN PERFORMANCE
Margin performance is presented in the following table.
Change vs.
prior year (pts.)
- ------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Gross margin 44.4% 45.0% 44.2% -.6 .8
SGA% (a) -26.9% -26.8% -28.3% -.1 1.5
Restructuring charges - - -.4% - .4
- ------------------------------------------------------------------------------------------------------------------
Operating margin 17.5% 18.2% 15.5% -.7 2.7
==================================================================================================================
(a) Selling, general, and administrative expense as a percentage of net
sales.
The 2003 gross margin was unfavorably impacted by significant asset
write-offs and exit costs related to cost-saving initiatives; higher
commodity, energy, and employee benefit costs; and an increase in
package-related promotional costs. These unfavorable factors were mitigated
by the favorable impact of operating leverage, pricing and mix
improvements, and productivity savings, resulting in only a 60 basis point
decline in gross margin versus the prior year. The SGA% was approximately
even with the prior year, as significant increases in brand-building and
innovation expenditures were offset by overhead savings.
The 2002 gross margin improvement was attributable primarily to higher
average pricing, improved mix, operating leverage, and cost savings related
to the Keebler acquisition. Our 2002 gross margin was also favorably
impacted by recognition of a $16.9 million curtailment gain related to a
change in certain retiree health care plans, largely offset by asset
impairment losses, an increase in package-related promotional costs, and
costs and asset write-offs associated with various ongoing supply chain
efficiency initiatives. The 2002 SGA% was 150 basis points lower than the
prior year, due principally to our adoption of SFAS No. 142 on January 1,
2002, which eliminated most of our intangibles amortization expense in
post-2001 years.
INTEREST EXPENSE
On March 26, 2001, we acquired Keebler Foods Company in a cash transaction
valued at $4.56 billion, which was financed through a combination of
short-term and long-term debt. As a result of this significant debt
issuance, interest expense increased dramatically in 2001 versus historical
periods and again in 2002, due to the extra quarterly period of interest on
Keebler acquisition-related debt. However, interest expense began to
decline in 2003 as a result of continuous pay-down of debt balances
throughout
Earning
Our
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24
2002 and 2003 and lower short-term market rates of interest. Since the
acquisition of Keebler in early 2001, our Company has paid down over $1.6
billion of debt, even early-retiring $172.9 million of long-term debt in
December 2003. The early retirement premium of $16.5 million, which
primarily represents accelerated interest, is included in 2003 interest
expense.
Change vs.
(dollars in millions) prior year
- -----------------------------------------------------------------------------------------------------------------
2003 2002 2001 2003 2002
- -----------------------------------------------------------------------------------------------------------------
Reported interest expense $ 371.4 $ 391.2 $ 351.5
Amounts capitalized - 1.0 2.9
- -----------------------------------------------------------------------------------------------------------------
Gross interest expense $ 371.4 $ 392.2 $ 354.4 -5.3% 10.7%
=================================================================================================================
We currently expect total-year 2004 interest expense to be reduced to
approximately $320 million, as we continue to pay down our debt balances.
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 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 2002 consists
primarily of a $24.7 million credit related to legal settlements, of which
$16.5 million was received in the first quarter with the remainder received
throughout subsequent quarters.
INCOME TAXES
Our consolidated effective tax rate has benefited from accounting changes,
tax planning initiatives, and favorable audit closures over the past
several years, declining from approximately 40% in 2001 to less than 33% in
2003. The resulting tax savings have been reinvested, in part, in
cost-saving programs, brand-building expenditures, and other growth
initiatives.
Change vs.
prior year (pts.)
- -------------------------------------------------------------------------------------------------------------
2003 2002 2001 2003 2002
- -------------------------------------------------------------------------------------------------------------
Effective income tax rate 32.7% 37.0% 40.1% -4.3 -3.1
=============================================================================================================
The effective income tax rate for 2001 of approximately 40% reflected the
impact of the Keebler acquisition on nondeductible goodwill and the level
of U.S. tax on foreign subsidiary earnings. 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 2002 effective income tax
rate was reduced to 37%.
Due primarily to the implementation of various tax planning initiatives and
audit closures, our 2003 effective income tax rate was lowered to 32.7%,
which includes over 200 basis points of single-event benefits. We expect an
ongoing rate for 2004 of approximately 35%.
LIQUIDITY AND CAPITAL RESOURCES
Our principal source of liquidity is operating cash flow 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 cash flow is defined as net cash provided by operating
activities reduced by expenditures for property additions.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 repurchases. Our cash flow metric is reconciled to
GAAP-basis operating cash flow as follows:
Change vs.
(dollars in millions) prior year
- -------------------------------------------------------------------------------------------------
2003 2002 2001 2003 2002
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities $1,171.0 $ 999.9 $1,132.0
Additions to properties (247.2) (253.5) (276.5)
- -------------------------------------------------------------------------------------------------
Cash flow $ 923.8 $ 746.4 $ 855.5 23.8% -12.8%
=================================================================================================
As a result of stronger than expected cash flow in both 2003 and 2002, we
made voluntary contributions to several of our major pension and retiree
health care plans. The after-tax impact of these contributions reduced cash
flow by approximately $37 million in 2003 and $254 million in 2002. After
adjusting for these differences, 2003 cash flow was within $40 million of
2002 cash flow, as the higher earnings in 2003 were overshadowed by
extremely strong working capital improvements in 2002.
The fourth quarter of 2003 marked the tenth consecutive quarter in which
our Company has achieved sequential improvement in the ratio of core
working capital (inventory and trade receivables less trade payables) to
net sales. For the year ended December 27, 2003, average core working
capital as a percentage of sales was 8.2%, compared to 8.8% for 2002 and
9.9% for 2001. For 2004, we expect continuing but more modest improvement
in our core working capital metric. Expenditures for property additions
represented 2.8% of 2003 net sales compared with 3.1% in 2002 and 3.7% in
2001. For 2004, expenditures for property additions are currently expected
to remain at approximately 3% of net sales and cash flow (as defined) is
expected to exceed the amount of net earnings.
Despite significant voluntary contributions in 2002, several of our pension
plans experienced shortfalls in market values of trust assets versus the
year-end 2002 accounting measurement of accumulated obligation. As a result
of this condition, we were required to record in our year-end 2002 balance
sheet an incremental reduction in equity of approximately $306 million. Due
to market gains and incremental funding during 2003 (net of increased
obligations), our plan position improved slightly at year-end 2003, and we
reversed approximately $48 million of this equity charge. These balance
sheet adjustments had no effect on our earnings and we
Kellogg
Company
25
do not expect them to impact our liquidity, capital resources, or our
ability to meet current debt covenants and maintain credit ratings.
To offset issuances under employee benefit programs, our Board of Directors
authorized management to repurchase up to $250 million of Kellogg common
stock during 2003 and up to $150 million in 2002. Under these
authorizations, we paid $90 million during 2003 for approximately 2.9
million shares and $101 million during 2002 for approximately 3.1 million
shares. We funded this repurchase program principally by proceeds from
employee stock option exercises. For 2004, our Board of Directors has
authorized stock repurchases for general corporate purposes up to $300
million.
We have repaid over $1.6 billion of debt originally issued for the Keebler
acquisition, reducing our total debt balance from approximately $6.8
billion at March 2001 to $5.2 billion at year-end 2003. Some of the
long-term debt has been redeemed prior to its maturity date. In September
2002, we redeemed $300.7 million of Notes due 2003, and in December 2003,
we redeemed $172.9 million of Notes due 2006. In January 2004, we repaid
$500 million of maturing seven-year Notes, initially replacing these Notes
with short-term debt.
To partially replace other maturing debt, in June 2003, we issued $500
million of five-year 2.875% fixed rate U.S. Dollar Notes. 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%.
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, including the pursuit of
selective growth opportunities, 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.
MARKET RISKS
Our Company is exposed to certain market risks, which exist as a part of
our ongoing business operations and we use derivative financial and
commodity instruments, where appropriate, to manage these risks. Our
Company, as a matter of policy, does not engage in trading or speculative
transactions. Refer to Note 12 within Notes to Consolidated Financial
Statements for further information on accounting policies related to
derivative financial and commodity instruments.
FOREIGN EXCHANGE RISK
Our Company is exposed to fluctuations in foreign currency cash flows
related to third-party purchases, intercompany loans and product shipments,
and nonfunctional currency denominated third-party debt. Our Company is
also exposed to fluctuations in the value of foreign currency investments
in subsidiaries and cash flows related to repatriation of these
investments. Additionally, our Company is exposed to volatility in the
translation of foreign currency earnings to U.S. Dollars. Primary exposures
include the U.S. Dollar versus the British Pound, Euro, Australian Dollar,
Canadian Dollar, and Mexican Peso, and in the case of inter-subsidiary
transactions, the British Pound versus the Euro. We assess foreign currency
risk primarily based on transactional cash flows and enter into forward
contracts, options, and currency swaps to reduce fluctuations in net long
or short currency positions. Forward contracts and options are generally
less than 18 months duration. Currency swap agreements are established in
conjunction with the term of underlying debt issuances.
The total notional amount of foreign currency derivative instruments at
year-end 2003 was $749.2 million, representing a settlement obligation of
$67.8 million. The total notional amount of foreign currency derivative
instruments at year-end 2002 was $816.7 million, representing a settlement
obligation of $35.2 million. All of these derivatives were hedges of
anticipated transactions, translational exposure, or existing assets or
liabilities, and mature within 18 months, except for one currency swap
transaction that matures in 2006. Assuming an unfavorable 10% change in
year-end exchange rates, the settlement obligation would have increased by
approximately $81.6 million in 2003 and $90.6 million in 2002. These
unfavorable changes would generally have been offset by favorable changes
in the values of the underlying exposures.
INTEREST RATE RISK
Our Company is exposed to interest rate volatility with regard to future
issuances of fixed rate debt and existing and future issuances of variable
rate debt. Primary exposures include movements in U.S. Treasury rates,
London Interbank Offered Rates (LIBOR), and commercial paper rates. We
currently use interest rate swaps and forward interest rate contracts to
reduce interest rate volatility and funding costs associated with certain
debt issues, and to achieve a desired proportion of variable versus fixed
rate debt, based on current and projected market conditions.
Note 7 within Notes to Consolidated Financial Statements provides
information on our Company's significant debt issues. The total notional
amount of interest rate derivative instruments at year-end 2003 was $1.91
billion, representing a settlement obligation of $2.1 million. The total
notional amount of interest rate derivative instruments at year-end 2002
was $1.83 billion, representing
Earning
Our
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26
a settlement obligation of $6.0 million. Assuming average variable rate
debt levels and issuances of fixed rate debt during the year, a one
percentage point increase in interest rates would have increased interest
expense by approximately $3.8 million in 2003 and $2.3 million in 2002.
PRICE RISK
Our Company is exposed to price fluctuations primarily as a result of
anticipated purchases of raw and packaging materials. Primary exposures
include corn, wheat, soybean oil, sugar, cocoa, and paperboard. We use the
combination of long cash positions with suppliers, and exchange-traded
futures and option contracts to reduce price fluctuations in a desired
percentage of forecasted purchases over a duration of generally less than
one year. The total notional amount of commodity derivative instruments at
year-end 2003 was $26.5 million, representing a settlement receivable of
$.2 million. Assuming a 10% decrease in year-end commodity prices, this
settlement receivable would have converted to a settlement obligation of
approximately $2.7 million, generally offset by a reduction in the cost of
the underlying material purchases. The total notional amount of commodity
derivative instruments at year-end 2002 was $25.4 million, representing a
settlement obligation of $.8 million. Assuming a 10% decrease in year-end
commodity prices, this settlement obligation would have increased by
approximately $1.6 million, generally offset by a reduction in the cost of
the underlying material purchases.
In addition to the derivative commodity instruments discussed above, we use
long cash positions with suppliers to manage a portion of our price
exposure. It should be noted that the exclusion of these positions from the
analysis above may be a limitation in assessing the net market risk of our
Company.
OFF-BALANCE SHEET ARRANGEMENTS AND OTHER OBLIGATIONS
OFF-BALANCE SHEET ARRANGEMENTS
Our off-balance sheet arrangements are generally limited to residual value
guarantees and secondary liabilities on operating leases of approximately
$15 million and third party loan guarantees as discussed in the following
paragraph.
Our Keebler subsidiary is guarantor on loans to independent contractors for
the purchase of DSD route franchises. At year-end 2003, there were total
loans outstanding of $15.2 million to 413 franchisees. Related to this
arrangement, our Company has established with a financial institution a
one-year renewable loan facility up to $17.0 million with a five-year
term-out and servicing arrangement. We have the right to revoke and resell
the route franchises in the event of default or any other breach of
contract by franchisees. Revocations have been infrequent. Our maximum
potential future payments under these guarantees are limited to the
outstanding loan principal balance plus unpaid interest. In accordance with
FIN 45 (refer to Note 1 within Notes to Consolidated Financial Statements),
we have recognized the fair value of guarantees associated with new loans
to DSD route franchisees issued beginning in 2003. These amounts are
insignificant.
CONTRACTUAL OBLIGATIONS
The following table summarizes future estimated cash payments to be made
under existing contractual obligations. Further information on debt
obligations is contained in Note 7 of Notes to Consolidated Financial
Statements. Further information on lease obligations is contained in Note
6.
Contractual obligations Payments due by period
- ------------------------------------------------------------------------------------------------
2009 and
(millions) Total 2004 2005 2006 2007 2008 beyond
- ------------------------------------------------------------------------------------------------
Long-term debt $4,866.2 $ 578.1 $ 278.6 $ 904.4 $ 2.0 $ 501.4 $2,601.7
Capital leases 5.6 1.6 1.5 1.5 1.0 - -
Operating leases 367.0 76.4 64.0 50.3 38.0 34.4 103.9
Purchase obligations (a) 369.9 191.5 68.3 43.8 30.4 29.6 6.3
Other long-term (b) 97.0 13.0 5.4 5.5 6.9 7.4 58.8
- ------------------------------------------------------------------------------------------------
Total $5,705.7 $ 860.6 $ 417.8 $1,005.5 $ 78.3 $ 572.8 $2,770.7
================================================================================================
(a) Purchase obligations consist primarily of fixed commitments under
various co-marketing agreements and to a lesser extent, of contracts
for future delivery of commodities, packaging materials, and
equipment, and service agreements. The amounts presented in the table
do not include items already recorded in accounts payable or other
current liabilities at year-end 2003, nor does the table reflect cash
flows we are likely to incur based on our plans, but are not obligated
to incur. Therefore, it should be noted that the exclusion of these
items from the table could be a limitation in assessing our total
future cash flows under contracts.
(b) Other long-term contractual obligations are those associated with
noncurrent liabilities recorded within the Consolidated Balance Sheet
at year-end 2003 and consist principally of projected commitments
under deferred compensation arrangements and other retiree benefits in
excess of those provided within our broad-based plans. We do not have
significant statutory or contractual funding requirements for our
broad-based retiree benefit plans during the periods presented and
have not included these amounts in the table. Refer to Notes 9 and 10
within Notes to Consolidated Financial Statements for further
information on these plans, including expected contributions for
fiscal year 2004.
SIGNIFICANT
ACCOUNTING ESTIMATES
Our significant accounting policies, as well as recently adopted
pronouncements, are discussed in Note 1 of Notes to Consolidated Financial
Statements. None of the pronouncements adopted in fiscal 2003 have had or
are expected to have a significant impact on our Company's financial
statements.
Our critical accounting estimates, which require significant judgments and
assumptions likely to have a material impact on our financial statements,
are generally limited to those governing the amount and timing of
recognition of consumer promotional expenditures, the assessment of the
carrying value of goodwill and other intangible assets, valuation of our
pension and other postretirement benefit obligations, and determination of
our income tax expense and liabilities. In addition, administrative
ambiguities concerning the Medicare Prescription Drug Improvement and
Modernization Act of 2003, as well as the current lack of FASB
authoritative guidance in this area, presently result in uncertainty
regarding the eventual financial impact of this legislative change on our
Company.
PROMOTIONAL EXPENDITURES
Our promotional activities are conducted either through the retail trade or
directly with consumers and involve in-store displays; fea-
Kellogg
Company
27
ture price discounts on our products; consumer coupons, contests, and
loyalty programs; and similar activities. The costs of these activities are
generally recognized at the time the related revenue is recorded, which
normally precedes the actual cash expenditure. Therefore, the recognition
of these costs requires management judgment regarding the volume of
promotional offers that will be redeemed by either the retail trade or
consumer. These estimates are made using various techniques including
historical data on performance of similar promotional programs. Differences
between estimated expense and actual redemptions are normally insignificant
and recognized as a change in management estimate in a subsequent period.
However, as our Company's total promotional expenditures represented nearly
30% of 2003 net sales, the likelihood exists of materially different
reported results if different assumptions or conditions were to prevail.
INTANGIBLES
Beginning in 2002, we follow SFAS No. 142 in evaluating impairment of
goodwill and other intangible assets. Under this standard, goodwill
impairment testing first requires a comparison between the carrying value
and fair value of a reporting unit with associated goodwill. Carrying value
is based on the assets and liabilities associated with the operations of
that reporting unit, which often requires allocation of shared or corporate
items among reporting units. The fair value of a reporting unit is based
primarily on our assessment of profitability multiples likely to be
achieved in a theoretical sale transaction. Similarly, impairment testing
of other intangible assets requires a comparison of carrying value to fair
value of that particular asset. Fair values of non-goodwill intangible
assets are based primarily on projections of future cash flows to be
generated from that asset. For instance, cash flows related to a particular
trademark would be based on a projected royalty stream attributable to
branded product sales. These estimates are made using various inputs
including historical data, current and anticipated market conditions,
management plans, and market comparables. We periodically engage third
party valuation consultants to assist in this process. At December 27,
2003, intangible assets, net, were $5.1 billion, consisting primarily of
goodwill, trademarks, and DSD delivery system associated with the Keebler
acquisition. While we currently believe that the fair value of all of our
intangibles exceeds carrying value, materially different assumptions
regarding future performance of our snacks business or the weighted average
cost of capital used in the valuations could result in significant
impairment losses.
RETIREMENT BENEFITS
Our Company sponsors a number of U.S. and foreign defined benefit employee
pension plans and also provides retiree health care and other welfare
benefits in the United States and Canada. Plan funding strategies are
influenced by tax regulations. A substantial majority of plan assets are
invested in a globally diversified portfolio of equity securities with
smaller holdings of bonds, real estate, and other investments. We follow
SFAS No. 87 "Employers' Accounting for Pensions" and SFAS No. 106
"Employers' Accounting for Postretirement Benefits Other Than Pensions" for
the measurement and recognition of obligations and expense related to our
retiree benefit plans. Embodied in both of these standards is the concept
that the cost of benefits provided during retirement should be recognized
over the employees' active working life. Inherent in this concept,
therefore, is the requirement to use various actuarial assumptions to
predict and measure costs and obligations many years prior to the
settlement date. Major actuarial assumptions that require significant
management judgment and have a material impact on the measurement of our
consolidated benefits expense and accumulated obligation include the
long-term rates of return on plan assets, the health care cost trend rates,
and the interest rates used to discount the obligations for our major
plans, which cover employees in the United States, United Kingdom, and
Canada.
To conduct our annual review of the long-term rate of return on plan
assets, we work with third party financial consultants to model expected
returns over a 20-year investment horizon with respect to the specific
investment mix of our major plans. The return assumptions used reflect a
combination of rigorous historical performance analysis and forward-looking
views of the financial markets including consideration of current yields on
long-term bonds, price-earnings ratios of the major stock market indices,
and long-term inflation. Our model currently incorporates a long-term
inflation assumption of 2.5% and an active management premium of 1% (net of
fees) validated by historical analysis. Although we review our expected
long-term rates of return annually, our benefit trust investment
performance for one particular year does not, by itself, significantly
influence our evaluation. Our expected rates of return are generally not
revised, provided these rates continue to fall within a "more likely than
not" corridor of between the 25th and 75th percentile of expected long-term
returns, as determined by our modeling process. Our current assumed rate of
return of 9.3% presently equates to approximately the 50th percentile
expectation.
Any future variance between the assumed and actual rates of return on our
plan assets is recognized in the calculated value of plan assets over a
five-year period and once recognized, experience gains and losses are
amortized using a declining-balance method over the average remaining
service period of active plan participants. Under this recognition method,
a 100 basis point shortfall in actual versus assumed performance of all of
our plan assets in year one would result in an arising experience loss of
approximately $20 million. The unfavorable impact on earnings in year two
would be less than $1 million, increasing to approximately $3 million in
year five. Approximately 80% of this experience loss would be amortized
through earnings at the end of year 20. Experience gains are recognized
similarly.
To conduct our annual review of health care cost trend rates, we work with
third party financial consultants to model our actual
Earning
Our
stripes
28
claims cost data over a five-year historical period, including an analysis
of pre-65 versus post-65 age group and other demographic trends. This data
is adjusted to eliminate the impact of plan changes and other factors that
would tend to distort the underlying cost inflation trends. Our initial
health care cost trend rate is reviewed annually and adjusted as necessary,
to remain consistent with our historical model, as well as any expectations
regarding short-term future trends. Our 2004 initial trend rate of 8.5%
compares to our recent five-year compound annual growth rate of
approximately 7%. Our initial rate is trended downward by 1% per year,
until the ultimate trend rate is reached. The ultimate trend rate is
adjusted annually, as necessary, to approximate the current economic view
on the rate of long-term inflation plus an appropriate health care cost
premium. The current ultimate trend rate of 4.5% is based on a long-term
inflation assumption of 2.5% plus a 2% premium.
To conduct our annual review of discount rates, we use several published
market indices with appropriate duration weighting to assess prevailing
rates on high quality debt securities. We also periodically use third party
financial consultants to model specific AA-rated (or the equivalent in
foreign jurisdictions) bond issues against the expected settlement cash
flows of our plans. The measurement dates for our benefit plans are
generally consistent with our Company's fiscal year end. Thus, we select
discount rates to measure our benefit obligations that are consistent with
market indices during December of each year.
Despite the above-described rigorous policies for selecting major actuarial
assumptions, we periodically experience differences between assumed and
actual experience. For 2004, we currently expect incremental amortization
of experience losses of approximately $20 million, arising largely from a
decline in discount rates at year-end 2003. Assuming actual future
experience is consistent with our current assumptions, annual amortization
of accumulated experience losses during each of the next several years
would remain approximately level with the 2004 amount.
INCOME TAXES
Our consolidated effective income tax rate is influenced by tax planning
opportunities available to us in the various jurisdictions in which we
operate. Significant judgement is required in determining our effective tax
rate and in evaluating our tax positions. We establish reserves when,
despite our belief that our tax return positions are supportable, we
believe that certain positions are likely to be challenged and that we may
not succeed. We adjust these reserves in light of changing facts and
circumstances, such as the progress of a tax audit. Our effective income
tax rate includes the impact of reserve provisions and changes to reserves
that we consider appropriate. While it is often difficult to predict the
final outcome or the timing of resolution of any particular tax matter, we
believe that our reserves reflect the probable outcome of known tax
contingencies. Favorable resolution would be recognized as a reduction to
our effective tax rate in the year of resolution. Our tax reserves are
presented in the balance sheet principally within accrued income taxes.
MEDICARE PRESCRIPTION BENEFITS
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare Part D, as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a
benefit that is at least actuarially equivalent to Medicare Part D. At
present, detailed regulations necessary to implement the Act have not been
issued, including those that would specify the manner in which actuarial
equivalency must be determined and the evidence required to demonstrate
actuarial equivalency to the Secretary of Health and Human Services.
Furthermore, the FASB has not yet issued authoritative guidance on
accounting for subsidies provided by the Act. To address this uncertainty,
in January 2004, the FASB issued Staff Position (FSP) FAS 106-1, which
permits plan sponsors to make a one-time election to defer recognition of
the effects of the Act in accounting for and making disclosures for
postretirement benefit plans until authoritative guidance is issued.
Accordingly, we have made this deferral election. However, when issued,
this authoritative guidance could require us to change previously reported
information. Based on current plan design, we believe certain health care
benefit plans covering a significant portion of our U.S. workforce are
likely to qualify for this subsidy, which once recognized, could result in
a moderate reduction in our annual health care expense.
Kellogg
Company
29
FUTURE OUTLOOK
Our long-term annual growth targets are low single-digit for internal net
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, despite several important challenges continuing from
2003:
- 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;
and
- economic volatility in Latin America.
In addition to the continuing challenges listed above, the following
important trends and uncertainties particular to 2004 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.
- We expect our 2004 consolidated effective income tax rate to be
approximately 35% versus less than 33% in 2003.
FORWARD-LOOKING STATEMENTS
Our Management's Discussion and Analysis and other parts of this Annual
Report contain "forward-looking statements" with projections concerning,
among other things, our strategy, financial principles, and plans;
initiatives, improvements, and growth; sales, gross margins, advertising,
promotion, merchandising, brand-building expenditures, operating profit,
and earnings per share; innovation opportunities; exit plans and costs
related to productivity initiatives; the impact of accounting changes and
FASB authoritative guidance to be issued; our ability to meet interest and
debt principal repayment obligations; common stock repurchases or debt
reduction; effective income tax rate; cash flow and core working capital;
capital expenditures; 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, such as 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:
- 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.
Earning
Our
Stripes
30
KELLOGG COMPANY AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(in millions, except per share data and number of employees)
2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING TRENDS
Net sales $ 8,811.5 $ 8,304.1 $ 7,548.4 $ 6,086.7 $ 6,156.5
Gross profit as a % of net sales 44.4% 45.0% 44.2% 44.1% 45.2%
Depreciation 359.8 346.9 331.0 275.6 273.6
Amortization 13.0 3.0 107.6 15.0 14.4
Advertising expense 698.9 588.7 519.2 604.2 674.1
Research and development expense 126.7 106.4 110.2 118.4 104.1
Operating profit (a) (d) 1,544.1 1,508.1 1,167.9 989.8 828.8
Operating profit as a % of net sales 17.5% 18.2% 15.5% 16.3% 13.5%
Interest expense 371.4 391.2 351.5 137.5 118.8
Earnings before cumulative
effect of accounting change (a) (b) (d) 787.1 720.9 474.6 587.7 338.3
Average shares outstanding:
Basic 407.9 408.4 406.1 405.6 405.2
Diluted 410.5 411.5 407.2 405.8 405.7
Earnings per share before cumulative
effect of accounting change (a) (b) (d)
Basic 1.93 1.77 1.17 1.45 .83
Diluted 1.92 1.75 1.16 1.45 .83
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOW TRENDS
Net cash provided from operating activities $ 1,171.0 $ 999.9 $ 1,132.0 $ 880.9 $ 795.2
Capital expenditures 247.2 253.5 276.5 230.9 266.2
Net cash provided from operating activities
reduced by capital expenditures (e) 923.8 746.4 855.5 650.0 529.0
Net cash used in investing activities (219.0) (188.8) (4,143.8) (379.3) (244.2)
Net cash provided from (used in) financing
activities (939.4) (944.4) 3,040.2 (441.8) (527.6)
Interest coverage ratio (c) 5.1 4.8 4.5 9.4 7.9
- ------------------------------------------------------------------------------------------------------------------------------------
CAPITAL STRUCTURE TRENDS
Total assets $ 10,230.8 $ 10,219.3 $ 10,368.6 $ 4,886.0 $ 4,808.7
Property, net 2,780.2 2,840.2 2,952.8 2,526.9 2,640.9
Short-term debt 898.9 1,197.3 595.6 1,386.3 521.5
Long-term debt 4,265.4 4,519.4 5,619.0 709.2 1,612.8
Shareholders' equity 1,443.2 895.1 871.5 897.5 813.2
- ------------------------------------------------------------------------------------------------------------------------------------
SHARE PRICE TRENDS
Stock price range $ 28-38 $ 29-37 $ 25-34 $ 21-32 $ 30-42
Cash dividends per common share 1.010 1.010 1.010 .995 .960
- ------------------------------------------------------------------------------------------------------------------------------------
Number of employees 25,250 25,676 26,424 15,196 15,051
====================================================================================================================================
(a) Operating profit for 2001 includes restructuring charges, net of credits,
of $33.3 ($20.5 after tax or $.05 per share). Operating profit for 2000
includes restructuring charges of $86.5 ($64.2 after tax or $.16 per
share). Operating profit for 1999 includes restructuring charges of $244.6
($156.4 after tax or $.40 per share). Earnings before cumulative effect of
accounting change for 1999 include disposition-related charges of $168.5
($111.5 after tax or $.27 per share).
(b) Earnings before cumulative effect of accounting change for 2001 exclude the
effect of a charge of $1.0 after tax to adopt SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities." Results for 2001 have been
restated to reflect the adoption of SFAS No. 145 in 2003 concerning the
income statement classification of losses from debt extinguishment. The net
loss of $7.4 incurred in 2001, which was originally classified as an
extraordinary loss, has been reclassified to Earnings before cumulative
effect of accounting change. Refer to Note 1 within Notes to Consolidated
Financial Statements for further information.
(c) Interest coverage ratio is calculated based on earnings before interest
expense, income taxes, depreciation, and amortization, divided by interest
expense.
(d) Results for 2001 include $103.6 ($85.0 after tax or $.21 per share) of
amortization which has been eliminated by SFAS No. 142 on a pro forma
basis. Amortization in pre-2001 years was insignificant. Refer to Note 1
within Notes to Consolidated Financial Statements for further information.
(e) The Company uses this non-GAAP financial measure to focus management and
investors on the amount of cash available for debt repayment, dividend
distributions, acquisition opportunities, and share repurchases.
Kellogg
Company
31
KELLOGG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
(millions, except per share data) 2003 2002 2001
- ---------------------------------------------------------------------------------------------------
NET SALES $ 8,811.5 $ 8,304.1 $ 7,548.4
- ---------------------------------------------------------------------------------------------------
Cost of goods sold 4,898.9 4,569.0 4,211.4
Selling, general, and administrative expense 2,368.5 2,227.0 2,135.8
Restructuring charges - - 33.3
- ---------------------------------------------------------------------------------------------------
OPERATING PROFIT $ 1,544.1 $ 1,508.1 $ 1,167.9
- ---------------------------------------------------------------------------------------------------
Interest expense 371.4 391.2 351.5
Other income (expense), net (3.2) 27.4 (23.9)
- ---------------------------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE $ 1,169.5 $ 1,144.3 $ 792.5
Income taxes 382.4 423.4 317.9
- ---------------------------------------------------------------------------------------------------
EARNINGS BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE $ 787.1 $ 720.9 $ 474.6
- ---------------------------------------------------------------------------------------------------
Cumulative effect of accounting change (net of tax) - - (1.0)
- ---------------------------------------------------------------------------------------------------
NET EARNINGS $ 787.1 $ 720.9 $ 473.6
- ---------------------------------------------------------------------------------------------------
PER SHARE AMOUNTS:
Earnings before cumulative effect of accounting change:
Basic $ 1.93 $ 1.77 $ 1.17
Diluted 1.92 1.75 1.16
Net earnings:
Basic 1.93 1.77 1.17
Diluted 1.92 1.75 1.16
==================================================================================================
Refer to Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Accumulated
Common stock Capital in Treasury stock other Total Total
------------ excess of Retained -------------- comprehensive shareholders' comprehensive
(millions) shares amount par value earnings shares amount income equity income
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2001 415.5 $103.8 $ 102.0 $1,501.0 9.8 ($ 374.0) ($ 435.3) $ 897.5
Net earnings 473.6 473.6 $ 473.6
Dividends (409.8) (409.8)
Other comprehensive income (116.1) (116.1) (116.1)
Stock options exercised and
other (10.5) (.1) (1.0) 36.9 26.3
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 415.5 $103.8 $ 91.5 $1,564.7 8.8 ($ 337.1) ($ 551.4) $ 871.5 $ 357.5
--------
Common stock repurchases 3.1 (101.0) (101.0)
Net earnings 720.9 720.9 720.9
Dividends (412.6) (412.6)
Other comprehensive income (302.0) (302.0) (302.0)
Stock options exercised and
other (41.6) (4.3) 159.9 118.3
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 28, 2002 415.5 $103.8 $ 49.9 $1,873.0 7.6 ($ 278.2) ($ 853.4) $ 895.1 $ 418.9
--------
Common stock repurchases 2.9 (90.0) (90.0)
Net earnings 787.1 787.1 787.1
Dividends (412.4) (412.4)
Other comprehensive income 124.2 124.2 124.2
Stock options exercised and
other (25.4) (4.7) 164.6 139.2
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 27, 2003 415.5 $103.8 $ 24.5 $2,247.7 5.8 ($ 203.6) ($ 729.2) $ 1,443.2 $ 911.3
====================================================================================================================================
Refer to Notes to Consolidated Financial Statements.
Earning
Our
Stripes
32
KELLOGG COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(millions, except share data) 2003 2002
- --------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and cash equivalents $ 141.2 $ 100.6
Accounts receivable, net 754.8 741.0
Inventories 649.8 603.2
Other current assets 251.4 318.6
----------- -----------
TOTAL CURRENT ASSETS $ 1,797.2 $ 1,763.4
----------- -----------
PROPERTY, NET 2,780.2 2,840.2
OTHER ASSETS 5,653.4 5,615.7
----------- -----------
TOTAL ASSETS $ 10,230.8 $ 10,219.3
=========== ===========
CURRENT LIABILITIES
Current maturities of long-term debt $ 578.1 $ 776.4
Notes payable 320.8 420.9
Accounts payable 703.8 619.0
Other current liabilities 1,163.3 1,198.6
----------- -----------
TOTAL CURRENT LIABILITIES $ 2,766.0 $ 3,014.9
----------- -----------
LONG-TERM DEBT 4,265.4 4,519.4
OTHER LIABILITIES 1,756.2 1,789.9
SHAREHOLDERS' EQUITY
Common stock, $.25 par value, 1,000,000,000 shares authorized
Issued: 415,451,198 shares in 2003 and 2002 103.8 103.8
Capital in excess of par value 24.5 49.9
Retained earnings 2,247.7 1,873.0
Treasury stock at cost:
5,751,578 shares in 2003 and 7,598,923 shares in 2002 (203.6) (278.2)
Accumulated other comprehensive income (loss) (729.2) (853.4)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY $ 1,443.2 $ 895.1
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 10,230.8 $ 10,219.3
=========== ===========
Refer to Notes to Consolidated Financial Statements.
Kellogg
Company
33
KELLOGG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(millions) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net earnings $ 787.1 $ 720.9 $ 473.6
Adjustments to reconcile net earnings to operating cash flows:
Depreciation and amortization 372.8 349.9 438.6
Deferred income taxes 74.8 111.2 71.5
Restructuring charges, net of cash paid - - 31.2
Other 76.1 67.0 (77.5)
Pension and other postretirement benefit plan contributions (184.2) (446.6) (76.3)
Changes in operating assets and liabilities 44.4 197.5 270.9
---------- -------- ----------
NET CASH PROVIDED FROM OPERATING ACTIVITIES $ 1,171.0 $ 999.9 $ 1,132.0
---------- -------- ----------
INVESTING ACTIVITIES
Additions to properties ($ 247.2) ($ 253.5) ($ 276.5)
Acquisitions of businesses - (2.2) (3,858.0)
Dispositions of businesses 14.0 60.9 -
Property disposals 13.8 6.0 10.1
Other .4 - (19.4)
---------- -------- ----------
NET CASH USED IN INVESTING ACTIVITIES ($ 219.0) ($ 188.8) ($ 4,143.8)
---------- -------- ----------
FINANCING ACTIVITIES
Net increase (reduction) of notes payable, with maturities less than or
equal to 90 days $ 208.5 ($ 226.2) ($ 154.0)
Issuances of notes payable, with maturities greater than 90 days 67.0 354.9 549.6
Reductions of notes payable, with maturities greater than 90 days (375.6) (221.1) (365.6)
Issuances of long-term debt 498.1 - 5,001.4
Reductions of long-term debt (956.0) (439.3) (1,608.4)
Net issuances of common stock 121.6 100.9 26.4
Common stock repurchases (90.0) (101.0) -
Cash dividends (412.4) (412.6) (409.8)
Other (.6) - .6
---------- -------- ----------
NET CASH PROVIDED FROM (USED IN) FINANCING ACTIVITIES ($ 939.4) ($ 944.4) $ 3,040.2
---------- -------- ----------
Effect of exchange rate changes on cash 28.0 2.1 (1.0)
---------- -------- ----------
Increase (decrease) in cash and cash equivalents $ 40.6 ($ 131.2) $ 27.4
Cash and cash equivalents at beginning of year 100.6 231.8 204.4
---------- -------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 141.2 $ 100.6 $ 231.8
========== ======== ==========
Refer to Notes to Consolidated Financial Statements.
Earning
Our
Stripes
34
KELLOGG COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Kellogg
Company and its majority-owned subsidiaries. Intercompany balances and
transactions are eliminated. Certain amounts in the prior-year financial
statements have been reclassified to conform to the current-year
presentation.
Beginning in 2002, the Company's fiscal year normally ends on the last
Saturday of December and as a result, a 53rd week is added every fifth or
sixth year. The Company's 2002 and 2003 fiscal years ended on December 28
and 27, respectively. The Company's 2004 fiscal year will end on January 1,
2005, and include a 53rd week. Prior to 2002, the Company had a calendar
year end.
CASH AND CASH EQUIVALENTS
Highly liquid temporary investments with original maturities of less than
three months are considered to be cash equivalents. The carrying amount
approximates fair value.
INVENTORIES
Inventories are valued at the lower of cost (principally average) or market.
PROPERTY AND OTHER LONG-LIVED ASSETS
Fixed assets are recorded at cost and depreciated over estimated useful
lives using straight-line methods for financial reporting and accelerated
methods for tax reporting. Cost includes an amount of interest associated
with significant capital projects.
The Company adopted Statement of Financial Accounting Standards (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 pre-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. 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).
GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted 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. Goodwill impairment testing first requires a
comparison between the carrying value and fair value of a reporting unit,
including goodwill allocated to it. If carrying value exceeds fair value,
goodwill is considered impaired. The amount of impairment loss is measured
as the difference between carrying value and implied fair value of goodwill,
which is determined in the same manner as the amount of goodwill recognized
in a business combination. Impairment testing for non-amortized intangibles
requires a comparison between the fair value and carrying value of the
intangible asset. If carrying value exceeds fair value, the intangible is
considered impaired and is reduced to fair value. The Company uses various
market valuation techniques to determine fair value of goodwill and other
intangible assets and periodically engages third party valuation consultants
for this purpose. Transitional impairment tests of goodwill and
non-amortized intangibles were required to be 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, effective January
1, 2002, the Company reclassified approximately $46 million from other
intangibles to goodwill. Refer to Note 15 for further information on the
Company's goodwill and other intangible assets.
For periods prior to 2002, intangible assets were amortized on a
straight-line basis over the estimated periods benefited, generally 40 years
for goodwill and periods ranging from 5 to 40 years for other intangible
assets.
REVENUE RECOGNITION AND MEASUREMENT
The Company recognizes sales upon delivery of its products to customers net
of applicable provisions for discounts, returns, and allowances.
Beginning January 1, 2002, the Company has applied the consensus reached by
the Emerging Issues Task Force (EITF) of the FASB in Issue No. 01-9
"Accounting for Consideration Given by a Vendor
Kellogg
Company
35
to a Customer or a Reseller of the Vendor's Products." Under this
consensus, generally, cash consideration is 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 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.
ADVERTISING
The costs of advertising are generally expensed as incurred and are
classified within SGA.
STOCK COMPENSATION
The Company currently 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 years, 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 are
presented below. Refer to Note 8 for further information on the Company's
stock compensation programs.
(millions, except per share data) 2003 2002 2001
- -----------------------------------------------------------------------------------
Stock-based compensation expense net of tax:
As reported $ 12.5 $ 10.7 $ 5.4
Pro forma $ 42.1 $ 52.8 $ 29.1
Net earnings:
As reported $ 787.1 $ 720.9 $ 473.6
Pro forma $ 757.5 $ 678.8 $ 449.9
Basic net earnings per share:
As reported $ 1.93 $ 1.77 $ 1.17
Pro forma $ 1.86 $ 1.66 $ 1.11
Diluted net earnings per share:
As reported $ 1.92 $ 1.75 $ 1.16
Pro forma $ 1.85 $ 1.65 $ 1.10
2003 2002 2001
- ---------------------------------------------------------------------
Risk-free interest rate 1.89% 3.58% 4.57%
Dividend yield 2.70% 2.92% 3.30%
Volatility 25.75% 29.71% 28.21%
Average expected term (years) 3.00 3.00 3.08
Fair value of options granted $ 4.75 $ 6.67 $ 5.05
DERIVATIVES AND HEDGING TRANSACTIONS
The Company adopted SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities" on January 1, 2001. This statement requires all
derivative instruments to be recorded on the balance sheet at fair value
and establishes criteria for designation and effectiveness of hedging
relationships. Upon adoption, 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. The charge to earnings relates
to the component of the derivative instruments' net loss that has been
excluded from the assessment of hedge effectiveness. Refer to Note 12 for
further information.
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 guidance 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. The adoption of SFAS No. 149 has had minimal impact on the
Company, except that cash flows associated with certain derivatives are now
being 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. The impact of
this classification change during 2003 was insignificant.
RECENTLY ADOPTED PRONOUNCEMENTS
EXIT ACTIVITIES
The Company has adopted SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities," 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 preexisting literature, certain costs associated with
exit activities were recognized when management committed to a plan. Under
SFAS
Earning
Our
Stripes
36
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,
adoption of this standard did not have a significant impact on the
Company's 2003 financial results. Refer to Notes 2 and 3 for further
information on the Company's exit activities during the periods presented.
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. Application of this guidance did
not 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," which was later amended by FIN 46-R issued
in December 2003. Under previous practice, entities were included in
consolidated financial statements based on controlling voting interests.
Under this interpretation, previously unconsolidated entities (referred to
as "variable interest entities") may 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. This interpretation is generally effective with the Company's fiscal
2004 first quarter. Management does not currently believe these
requirements are applicable to any existing financial arrangement of the
Company.
LEASING
In May 2003, the EITF 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, the impact of
this consensus during 2003 was insignificant.
EXTINGUISHMENT OF DEBT
Net earnings for 2001 originally included 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. Effective with its
2003 fiscal year, the Company adopted 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 are no longer classified as extraordinary items.
Accordingly, the extraordinary loss for 2001 has been reclassified to
conform to the presentation for 2003 and subsequent years.
MEDICARE PRESCRIPTION BENEFITS
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare Part D, as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a
benefit that is at least actuarially equivalent to Medicare Part D. At
present, detailed regulations necessary to implement the Act have not been
issued, including those that would specify the manner in which actuarial
equivalency must be determined and the evidence required to demonstrate
actuarial equivalency to the Secretary of Health and Human Services.
Furthermore, the FASB has not yet issued authoritative guidance on
accounting for subsidies provided by the Act. To address this uncertainty,
in January 2004, the FASB issued Staff Position (FSP) FAS 106-1, which
permits plan sponsors to make a one-time election to defer recognition of
the effects of the Act in accounting for and making disclosures for
postretirement benefit plans until authoritative guidance is issued.
Accordingly, the Company has made this deferral election. However, when
issued, this authoritative guidance could require the Company to change
previously reported information. Based on current plan design, management
believes certain health care benefit plans covering a significant portion
of the Company's U.S. workforce are likely to qualify for this subsidy,
which once recognized, could result in a moderate reduction in our annual
health care expense.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
NOTE 2 KEEBLER ACQUISITION
On March 26, 2001, the Company acquired Keebler Foods Company ("Keebler")
in a cash transaction valued at $4.56 billion. The acquisition was
accounted for under the purchase method and
Kellogg
Company
37
was financed through a combination of short-term and long-term debt. The
components of intangible assets included in the final allocation of
purchase price were (in millions): trademarks and tradenames-$ 1,310.0,
direct store door (DSD) delivery system-$590.0, goodwill-$2,938.5. 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 were no longer amortized after
2001, but are subject to annual impairment reviews. Unaudited pro forma
combined results as if the Company had acquired Keebler as of the beginning
of 2001 are (in millions except per share data): net sales-$8,049.8,
earnings before cumulative effect of accounting change-$430.6, net
earnings-$429.6, net earnings per share (basic and diluted)-$1.06. These
pro forma results include amortization of the acquired intangibles and
interest expense on debt assumed issued to finance the purchase. The pro
forma results are not necessarily indicative of what actually would have
occurred if the acquisition had been completed as of the beginning of 2001,
nor are they necessarily indicative of future consolidated results.
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 Keebler, as presented in the table below.
During the year ended December 27, 2003, $6.7 million of excess reserves
were reversed to goodwill. 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. Acquisition-date exit plans were substantially completed during
2003, with remaining reserves consisting primarily of contractual
obligations for severance and leases extending through 2011.
Lease & other
Employee Employee contract Facility closure
(millions) severance benefits relocation termination costs Total
- ----------------------------------------------------------------------------------------------------------------------
Total reserve at acquisition date:
Original estimate $ 59.3 $ 8.6 $12.3 $ 10.4 $ 90.6
Purchase accounting adjustments (10.3) (7.1) (.5) (1.4) (19.3)
- ----------------------------------------------------------------------------------------------------------------------
Adjusted $ 49.0 $ 1.5 $11.8 $ 9.0 $ 71.3
Amounts utilized during 2001 (23.9) (.8) (.4) (2.9) (28.0)
Amounts utilized during 2002 (17.9) (.1) (1.8) (4.2) (24.0)
2003 activity:
Utilized (5.0) (.1) (2.9) (.3) (8.3)
Reversed (1.9) (.5) (2.8) (1.5) (6.7)
- ----------------------------------------------------------------------------------------------------------------------
REMAINING RESERVE
AT DECEMBER 27, 2003 $ .3 $ - $ 3.9 $ .1 $ 4.3
======================================================================================================================
Exit plans implemented during the two-year period following the acquisition
date included consolidation of various administrative functions in Battle
Creek, Michigan; consolidation of ice cream cone and pie crust operations
within a single Chicago, Illinois facility; reconfiguration of Keebler's
DSD system in the southeastern United States to accommodate Kellogg snack
product volume; closing of the Denver, Colorado bakery and several leased
distribution centers; and transferring some production from the Grand
Rapids, Michigan bakery to other facilities. As a result of these
initiatives, over 800 employee positions were relocated or eliminated.
These exit plans also included the divesture of some of Keebler's
private-label operations. During April 2002, the Company sold certain
assets of the Bake-Line unit, including a bakery in Marietta, Oklahoma, to
Atlantic Baking Group, Inc. for approximately $65 million in cash. In
January 2003, the Company sold additional private-label operations,
including a bakery in Cleveland, Tennessee, 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 EXIT ACTIVITIES AND OTHER CHARGES
2003-EXIT ACTIVITIES
To position the Company for sustained, reliable growth in earnings and cash
flow for the long term, management is undertaking a series of cost-saving
initiatives. Some of these initiatives are still in the planning stages and
individual actions are being announced as plans are finalized. Major
actions implemented in 2003 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 involved the exit of a
leased facility and separation of approximately 140 employees during 2003.
The Company incurred approximately $6 million in exit costs and asset
write-offs during 2003 related to this initiative.
The manufacturing capacity rationalization in the Mercosur region of Latin
America involved the closure of an owned facility in Argentina and
separation of approximately 85 plant and administrative employees during
2003. The Company recorded an impairment loss of approximately $6 million
to reduce the carrying value of the manufacturing facility to estimated
fair value, and incurred approximately $2 million of severance and closure
costs during 2003 to complete this initiative. Beginning in 2004, the
Company is importing its products for sale in Argentina from other Latin
America facilities.
The plant workforce reduction in Great Britain resulted from changes in
plant crewing to better match the work pattern to the demand cycle.
Approximately 130 hourly and salaried employee positions have been
eliminated through voluntary severance and early retirement programs.
During 2003, the Company incurred approximately $18 million in separation
benefit costs related to this initiative.
Earning
Our
Stripes
38
Taking into account all of these major initiatives, plus other various
plant productivity and overhead reduction projects, the Company recorded
total charges of approximately $71 million during 2003, comprised of $40
million in asset write-offs, $8 million for pension settlements, and $23
million in severance and other cash exit costs. These charges were recorded
principally in cost of goods sold and impacted the Company's operating
segments as follows (in millions): U.S.-$36, Europe-$21, Latin America-$8,
all other-$6. Reserves for exit costs at December 27, 2003, were
approximately $19 million, principally representing severance to be paid
out during the first half of 2004.
2003-IMPAIRMENTS
During 2003, the Company recorded in SGA an impairment loss of $10 million
to reduce the carrying value of a contract-based intangible asset. The
asset is associated with a long-term licensing agreement principally in the
United States and the decline in value was based on the proportionate
decline in estimated future cash flows to be derived from the contract
versus original projections.
PRIOR YEARS-EXIT ACTIVITIES
Operating profit for 2001 includes net restructuring charges of $33.3
million ($20.5 million after tax or $.05 per share), comprised of $48.3
million in charges and $15.0 million in credits.
The 2001 charges of $48.3 million are related to preparing Kellogg for the
Keebler integration and continued actions supporting the Company's growth
strategy. Specific initiatives included a headcount reduction of about 30
in U.S. and global Company management, rationalization of product offerings
and other actions to combine the Kellogg and Keebler logistics systems, and
reductions in convenience foods capacity in Southeast Asia. Approximately
two-thirds of the charges were comprised of asset write-offs with the
remainder consisting of employee separation benefits and other cash costs.
The 2001 credits of $15.0 million result from adjustments to various
restructuring and asset disposal reserves. With numerous multi-year
streamlining initiatives nearing completion in late 2001, management
conducted an assessment of post-2001 reserve needs, which resulted in net
reductions of $8.8 million for cash outlays and $6.2 million for asset
disposals. (Asset disposal reserves are reported within Property, net, on
the Consolidated Balance Sheet.) The reduction in cash outlays relates
primarily to lower-than-anticipated employee severance and asset removal
expenditures, and higher-than-anticipated asset sale proceeds.
Total cash outlays incurred for restructuring programs were approximately
$8 million in 2002 and $35 million in 2001. At the end of 2001, remaining
reserves related to all restructuring programs were $9.9 million, comprised
of $6.4 million for severance and $3.5 million for asset removal. At the
end of 2002, all restructuring programs were complete and remaining
reserves of $1.4 million consisted solely of long-term contractual
obligations for employee severance.
As a result of the Keebler acquisition in March 2001, the Company assumed
$14.9 million of reserves for severance and facility closures related to
Keebler's ongoing restructuring and acquisition-related synergy
initiatives. Approximately $5 million of those reserves were utilized in
2001, with the remainder being attributable primarily to noncancelable
lease obligations extending through 2006.
PRIOR YEARS-IMPAIRMENTS
Cost of goods sold for 2002 includes an impairment loss of $5 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 completed a sale of
this facility in late 2003, and the carrying value of the property
approximated the net sales proceeds.
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 asset sales. Other income (expense), net for 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 2002 consists
primarily of a $24.7 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:
Kellogg
Company
39
Earnings before cumulative effect of accounting change
Average
shares
(millions, except per share data) Earnings outstanding Per share
- ---------------------------------------------------------------------------------
2003
Basic $ 787.1 407.9 $ 1.93
Dilutive employee stock options -- 2.6 (.01)
- ---------------------------------------------------------------------------------
Diluted $ 787.1 410.5 $ 1.92
=================================================================================
2002
Basic $ 720.9 408.4 $ 1.77
Dilutive employee stock options -- 3.1 (.02)
- ---------------------------------------------------------------------------------
Diluted $ 720.9 411.5 $ 1.75
=================================================================================
2001 (a)
Basic $ 474.6 406.1 $ 1.17
Dilutive employee stock options -- 1.1 (.01)
- ---------------------------------------------------------------------------------
Diluted $ 474.6 407.2 $ 1.16
=================================================================================
(a) Results for 2001 have been restated to reflect the adoption of SFAS No. 145
in 2003 concerning the income statement classification of losses from debt
extinguishment. The net loss of $7.4 incurred in 2001, which was originally
classified as an extraordinary loss, has been reclassified to Earnings
before cumulative effect of accounting change. Refer to Note 1 for further
information.
COMPREHENSIVE INCOME
Comprehensive income includes all changes in equity during a period except
those resulting from investments by or distributions to shareholders.
Comprehensive income for the periods presented consists of net earnings,
minimum pension liability adjustments (refer to Note 9), unrealized gains
and losses on cash flow hedges pursuant to SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities", and foreign currency
translation adjustments pursuant to SFAS No. 52 "Foreign Currency
Translation" as follows:
Tax
Pretax (expense) After-tax
(millions) amount benefit amount
- ------------------------------------------------------------------------------------
2003
Net earnings $ 787.1
Other comprehensive income:
Foreign currency translation adjustments $ 81.6 $ - 81.6
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges (18.7) 6.6 (12.1)
Reclassification to net earnings 10.3 (3.8) 6.5
Minimum pension liability adjustments 75.7 (27.5) 48.2
- ------------------------------------------------------------------------------------
$148.9 ($ 24.7) 124.2
- -----------------------------------------------------------------------------------
Total comprehensive income $ 911.3
===================================================================================
Tax
Pretax (expense) After-tax
(millions) amount benefit amount
- --------------------------------------------------------------------------------------
2002
Net earnings $ 720.9
Other comprehensive income:
Foreign currency translation adjustments $ 1.6 $ -- 1.6
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges (2.9) 1.3 (1.6)
Reclassification to net earnings 6.9 (2.7) 4.2
Minimum pension liability adjustments (453.5) 147.3 (306.2)
- --------------------------------------------------------------------------------------
($ 447.9) $ 145.9 (302.0)
- --------------------------------------------------------------------------------------
Total comprehensive income $ 418.9
======================================================================================
Tax
Pretax (expense) After-tax
(millions) amount benefit amount
- ---------------------------------------------------------------------------------------
2001
Net earnings $ 473.6
Other comprehensive income:
Foreign currency translation adjustments ($ 60.4) $ -- (60.4)
Cash flow hedges:
Unrealized gain (loss) on
cash flow hedges (86.3) 31.9 (54.4)
Reclassification to net earnings 8.8 (3.3) 5.5
Minimum pension liability adjustments (9.8) 3.0 (6.8)
- --------------------------------------------------------------------------------------
($147.7) $ 31.6 (116.1)
- --------------------------------------------------------------------------------------
Total comprehensive income $ 357.5
======================================================================================
Accumulated other comprehensive income (loss) at year end consisted of the
following:
(millions) 2003 2002
- --------------------------------------------------------------------------------
Foreign currency translation adjustments ($ 406.0) ($ 487.6)
Cash flow hedges - unrealized net loss (51.9) (46.3)
Minimum pension liability adjustments (271.3) (319.5)
- --------------------------------------------------------------------------------
Total accumulated other comprehensive income (loss) ($ 729.2) ($ 853.4)
================================================================================
NOTE 6 LEASES AND OTHER
COMMITMENTS
The Company's leases are generally for equipment and warehouse space. Rent
expense on all operating leases was $80.5 million in 2003, $89.5 million in
2002, and $100.0 million in 2001. Additionally, the Company is subject to
residual value guarantees and secondary liabilities on operating leases
totaling approximately $15 million, for which liabilities of $1.8 million
had been recorded at December 27, 2003.
At December 27, 2003, future minimum annual lease commitments under
noncancelable capital and operating leases were as follows:
Operating Capital
(millions) leases leases
- -----------------------------------------------------------------
2004 $ 76.4 $ 1.6
2005 64.0 1.5
2006 50.3 1.5
2007 38.0 1.0
2008 34.4 --
2009 and beyond 103.9 --
- ----------------------------------------------------------------
Total minimum payments $367.0 $ 5.6
Amount representing interest (.7)
- ----------------------------------------------------------------
Obligations under capital leases 4.9
Obligations due within one year 1.3
- ----------------------------------------------------------------
Long-term obligations under capital
leases $ 3.6
================================================================
The Company's Keebler subsidiary is guarantor on loans to independent
contractors for the purchase of DSD route franchises. At year-end 2003,
there were total loans outstanding of $15.2 million to 413 franchisees. All
loans are variable rate with a term of 10 years. Related to this
arrangement, the Company has established with a financial institution a
one-year renewable loan facility up to $17.0 million with a five-year
term-out and servicing arrangement. The Company has the right to revoke and
resell the
Earning
Our
Stripes
40
route franchises in the event of default or any other breach of contract by
franchisees. Revocations are infrequent. The Company's maximum potential
future payments under these guarantees are limited to the outstanding loan
principal balance plus unpaid interest. In accordance with FASB
Interpretation No. 45 (refer to Note 1), we have recognized the fair value
of guarantees associated with new loans to DSD route franchisees issued
beginning in 2003. These amounts are insignificant.
The Company has provided various standard indemnifications in agreements to
sell business assets and lease facilities over the past several years,
related primarily to pre-existing tax, environmental, and employee benefit
obligations. Certain of these indemnifications are limited by agreement in
either amount and/or term and others are unlimited. The Company has also
provided various "hold harmless" provisions within certain service type
agreements. Because the Company is not currently aware of any actual
exposures associated with these indemnifications, management is unable to
estimate the maximum potential future payments to be made. At December 27,
2003, the Company had not recorded any liability related to these
indemnifications.
NOTE 7 DEBT
Notes payable at year end consisted of commercial paper borrowings in the
United States and, to a lesser extent, bank loans of foreign subsidiaries
at competitive market rates, as follows:
(dollars in millions) 2003 2002
- -----------------------------------------------------------------------------------
EFFECTIVE Effective
PRINCIPAL INTEREST Principal interest
AMOUNT RATE amount rate
- -----------------------------------------------------------------------------------
U.S. commercial paper $296.0 1.2% $409.8 2.0%
Canadian commerical paper 15.3 3.0% - -
Other 9.5 11.1
- -----------------------------------------------------------------------------------
$320.8 $420.9
==================================================================================
Long-term debt at year end consisted primarily of fixed rate issuances of
U.S. and Euro Dollar Notes, as follows:
(millions) 2003 2002
- ----------------------------------------------------------------------------------
(a) 4.875% U.S. Dollar Notes due 2005 $ 200.0 $ 200.0
(b) 6.625% Euro Dollar Notes due 2004 500.0 500.0
(c) 5.5% U.S. Dollar Notes due 2003 - 699.1
(c) 6.0% U.S. Dollar Notes due 2006 824.2 995.8
(c) 6.6% U.S. Dollar Notes due 2011 1,493.6 1,492.7
(c) 7.45% U.S. Dollar Debentures due 2031 1,086.3 1,085.8
(d) 4.49% U.S. Dollar Notes due 2006 225.0 300.0
(e) 2.875% U.S. Dollar Notes due 2008 499.9 -
Other 14.5 22.4
- ----------------------------------------------------------------------------------
4,843.5 5,295.8
Less current maturities (578.1) (776.4)
- ----------------------------------------------------------------------------------
Balance at year end $4,265.4 $4,519.4
==================================================================================
(a) In October 1998, the Company issued $200 of seven-year 4.875% fixed
rate U.S. Dollar Notes to replace maturing long-term debt. In
conjunction with this issuance, the Company settled $200 notional
amount of interest rate forward swap agreements, which, when combined
with original issue discount, effectively fixed the interest rate on
the debt at 6.07%.
(b) In January 1997, the Company issued $500 of seven-year 6.625% fixed
rate Euro Dollar Notes. In conjunction with this issuance, the Company
settled $500 notional amount of interest rate forward swap agreements,
which effectively fixed the interest rate on the debt at 6.354%. These
Notes were repaid in January 2004.
(c) In March 2001, the Company issued $4,600 of long-term debt
instruments, further described in the table below, primarily to
finance the acquisition of Keebler Foods Company (refer to Note 2).
Initially, these instruments were privately placed, or sold outside
the United States, in reliance on exemptions from registration under
the Securities Act of 1933, as amended (the "1933 Act"). The Company
then exchanged new debt securities for these initial debt instruments,
with the new debt securities being substantially identical in all
respects to the initial debt instruments, except for being registered
under the 1933 Act. These debt securities contain standard events of
default and covenants. The Notes due 2006 and 2011, and the Debentures
due 2031 may be redeemed in whole or part by the Company at any time
at prices determined under a formula (but not less than 100% of the
principal amount plus unpaid interest to the redemption date).
In conjunction with this issuance, the Company settled $1,900 notional
amount of forward-starting interest rate swaps for approximately $88 in
cash. The swaps effectively fixed a portion of the interest rate on an
equivalent amount of debt prior to issuance. The swaps were designated as
cash flow hedges pursuant to SFAS No. 133 (refer to Note 12). As a result,
the loss on settlement (net of tax benefit) of $56 was recorded in other
comprehensive income, and is being amortized to interest expense over
periods of 5 to 30 years. The effective interest rates presented in the
following table reflect this amortization expense, as well as discount on
the debt.
Principal Effective
(dollars in millions) amount Net proceeds interest rate
- -------------------------------------------------------------------------------------
5.5% U.S. Dollar Notes due 2003 $ 1,000.0 $ 997.4 5.64%
6.0% U.S. Dollar Notes due 2006 1,000.0 993.5 6.39%
6.6% U.S. Dollar Notes due 2011 1,500.0 1,491.2 7.08%
7.45% U.S. Dollar Debentures due 2031 1,100.0 1,084.9 7.62%
- --------------------------------------------------------------------------------
$ 4,600.0 $ 4,567.0
================================================================================
In September 2002, the Company redeemed $300.7 of the Notes due 2003
and a subsidiary of the Company issued $400 of U.S. commercial paper.
In April 2003, the Company repaid the remainder of the Notes due 2003.
The Company initially replaced this debt with U.S. short-term debt and
subsequently issued the long-term debt described in (e). In December
2003, the Company redeemed $172.9 of the Notes due 2006.
(d) In November 2001, a subsidiary of the Company issued $375 of five-year
4.49% fixed rate U.S. Dollar Notes to replace other maturing debt.
These Notes are guaranteed by the Company and mature $75 per year over
the five-year term. These Notes, which were privately placed, contain
standard warranties, events of default, and covenants. They also
require the maintenance of a specified consolidated interest expense
coverage ratio, and limit capital lease obligations and subsidiary
debt. In conjunction with this issuance, the subsidiary of the Company
entered into a $375 notional US$/Pound Sterling currency swap, which
effectively converted this debt into a 5.302% fixed rate Pound
Sterling obligation for the duration of the five-year term.
(e) In June 2003, the Company issued $500 of five-year 2.875% fixed rate
U.S. Dollar Notes, using the proceeds from these Notes to replace
maturing long-term debt. These Notes were issued under an existing
shelf registration statement. In conjunction with this issuance, the
Company settled $250 notional amount of forward interest rate
contracts for a loss of $11.8, 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%.
At December 27, 2003, the Company had $2.0 billion of short-term lines of
credit, virtually all of which were unused and available for borrowing on
an unsecured basis. These lines were comprised principally of a 364-Day
Credit Agreement, which was renewed in January 2004, and a Five-Year Credit
Agreement, expiring in January 2006. The 364-day agreement permits the
Company or certain subsidiaries to borrow up to $650 million. The five-year
agreement permits the Company or certain subsidiaries to borrow up to $1.15
billion (or certain amounts in foreign currencies). These two credit
agreements contain standard warranties, events of default, and covenants.
They also require the maintenance of a specified amount of consolidated net
worth and a specified consolidated interest expense coverage ratio, and
limit capital lease obligations and subsidiary debt.
Scheduled principal repayments on long-term debt are (in millions):
2004-$578.1; 2005-$278.6; 2006-$904.4; 2007-$2.0; 2008-$501.4; 2009 and
beyond-$2,601.7.
Interest paid was (in millions): 2003-$372; 2002-$386; 2001-$303. Interest
expense capitalized as part of the construction cost of fixed assets was
(in millions): 2003-$0; 2002-$1.0; 2001-$2.9.
NOTE 8 STOCK COMPENSATION
The Company uses various equity-based compensation programs to provide
long-term performance incentives for its global workforce. Currently, these
incentives are administered through several plans, as described below.
Kellogg
Company
41
The 2003 Long-Term Incentive Plan ("2003 Plan"), approved by shareholders
in 2003, permits benefits to be awarded to employees and officers in the
form of incentive and non-qualified stock options, performance shares or
performance share units, restricted stock or restricted stock units, and
stock appreciation rights. The 2003 Plan authorizes the issuance of a total
of (a) 25 million shares plus (b) shares not issued under the 2001
Long-Term Incentive Plan (the "2001 Plan"), with no more than 5 million
shares to be issued in satisfaction of performance units, performance-
based restricted shares and other awards (excluding stock options and stock
appreciation rights), and with additional annual limitations on awards or
payments to individual participants. Options granted under the 2003 Plan
and 2001 Plan generally vest over two years, subject to earlier vesting if
a change of control occurs. Restricted stock and performance share grants
under the 2003 Plan and the 2001 Plan generally vest in three years,
subject to earlier vesting and payment if a change in control occurs.
The Non-Employee Director Stock Plan ("Director Plan") was approved by
shareholders in 2000 and allows each eligible nonemployee director to
receive 1,700 shares of the Company's common stock annually and annual
grants of options to purchase 5,000 shares of the Company's common stock.
Shares other than options are placed in the Kellogg Company Grantor Trust
for Non-Employee Directors (the "Grantor Trust"). Under the terms of the
Grantor Trust, shares are available to a director only upon termination of
service on the Board. Under this plan, awards were as follows: 2003-55,000
options and 18,700 shares; 2002-50,850 options and 18,700 shares;
2001-55,000 options and 17,000 shares.
Options under all plans described above are granted with exercise prices
equal to the fair market value of the Company's common stock at the time of
the grant and have a term of no more than ten years, if they are incentive
stock options, or no more than ten years and one day, if they are
non-qualified stock options. In addition, these plans permit stock option
grants to contain an accelerated ownership feature ("AOF"). An AOF option
is generally granted when Company stock is used to pay the exercise price
of a stock option or any taxes owed. The holder of the option is generally
granted an AOF option for the number of shares so used with the exercise
price equal to the then fair market value of the Company's stock. For all
AOF options, the original expiration date is not changed but the options
vest immediately.
In addition to employee stock option grants presented in the tables below,
under its long-term incentive plans, the Company made restricted stock
grants to eligible employees as follows (approximate number of shares):
2003-209,000; 2002-132,000; 2001-300,000. Additionally, performance units
were awarded to a limited number of senior executive-level employees for
the achievement of cumulative three-year performance targets as follows:
awarded in 2001 for cash flow targets ending in 2003; awarded in 2002 for
sales growth targets ending in 2004; awarded in 2003 for gross margin
targets ending in 2005. If the performance targets are met, the award of
units represents the right to receive shares of common stock (or a
combination of shares and cash) equal to the dollar award valued on the
vesting date. No awards are earned unless a minimum threshold is attained.
The 2001 award was earned at 200% of target and vested in February 2004 for
a total dollar equivalent of $15.5 million. The maximum future dollar award
that could be attained under the 2002 and 2003 awards is approximately $19
million.
The 2002 Employee Stock Purchase Plan was approved by shareholders in 2002
and permits eligible employees to purchase Company stock at a discounted
price. This plan allows for a maximum of 2.5 million shares of Company
stock to be issued at a purchase price equal to the lesser of 85% of the
fair market value of the stock on the first or last day of the quarterly
purchase period. Total purchases through this plan for any employee are
limited to a fair market value of $25,000 during any calendar year. Shares
were purchased by employees under this plan as follows (approximate number
of shares): 2003-248,000; 2002-119,000. Additionally, during 2002, a
foreign subsidiary of the Company established a stock purchase plan for its
employees. Subject to limitations, employee contributions to this plan are
matched 1:1 by the Company. Under this plan, shares were granted by the
Company to match an approximately equal number of shares purchased by
employees as follows (approximate number of shares): 2003-94,000;
2002-82,000.
The Executive Stock Purchase Plan was established in 2002 to encourage and
enable certain eligible employees of the Company to acquire Company stock,
and to align more closely the interests of those individuals and the
Company's shareholders. This plan allows for a maximum of 500,000 shares of
Company stock to be issued. Under this plan, shares were granted by the
Company to executives in lieu of cash bonuses as follows (approximate
number of shares): 2003-11,000; 2002-14,000.
Transactions under these plans are presented in the tables below. Refer to
Note 1 for information on the Company's method of accounting for these
plans.
Earning
Our
Stripes
42
(millions) 2003 2002 2001
- ---------------------------------------------------------------------------------------
Under option, beginning of year 38.2 37.0 23.4
Granted 7.5 9.2 17.1
Exercised (6.0) (5.2) (1.3)
Cancelled (2.7) (2.8) (2.2)
- ---------------------------------------------------------------------------------------
Under option, end of year 37.0 38.2 37.0
- ---------------------------------------------------------------------------------------
Exercisable, end of year 24.4 20.1 16.9
=======================================================================================
Average prices per share
Under option, beginning of year $ 33 $ 31 $ 34
Granted 31 33 27
Exercised 28 27 25
Cancelled 35 32 34
- ---------------------------------------------------------------------------------------
Under option, end of year $ 33 $ 33 $ 31
- ---------------------------------------------------------------------------------------
Exercisable, end of year $ 34 $ 34 $ 36
=======================================================================================
Shares available, end of year,
for stock-based awards that may be granted
under the following plans:
Kellogg Employee Stock Ownership Plan 1.3 .6 2.8
2000 Non-Employee Director Stock Plan .6 .6 .9
2001 Long-Term Incentive Plan - 10.1 16.1
2002 Employee Stock Purchase Plan 2.1 2.4 -
Executive Stock Purchase Plan .5 .5 -
2003 Long-Term Incentive Plan (a) 30.5 - -
- ---------------------------------------------------------------------------------------
Total 35.0 14.2 19.8
=======================================================================================
(a) Refer to description of 2003 Plan within this note for restrictions on
availability.
Employee stock options outstanding and exercisable under these plans as of
December 27, 2003, were:
(millions, except per share data)
Outstanding Exercisable
----------------------------------- -------------------
Weighted
Weighted average Weighted
Range of average remaining average
exercise Number exercise contractual Number exercise
prices of options price life (yrs.) of options price
- ----------------------------------------------------------------------
$19 - 28 10.2 $ 26 7.0 7.8 $ 27
29 - 34 8.9 31 8.7 2.6 33
35 - 36 10.2 35 7.8 6.6 35
37 - 51 7.7 41 4.2 7.4 42
- ----------------------------------------------------------------------
37.0 24.4
====================================================================
NOTE 9 PENSION BENEFITS
The Company sponsors a number of U.S. and foreign pension plans to provide
retirement benefits for its employees. The majority of these plans are
funded or unfunded defined benefit plans, although the Company does
participate in a few multiemployer or other defined contribution plans for
certain employee groups. Defined benefits for salaried employees are
generally based on salary and years of service, while union employee
benefits are generally a negotiated amount for each year of service. The
Company uses its fiscal year end as the measurement date for the majority
of its plans.
OBLIGATIONS AND FUNDED STATUS
The aggregate change in projected benefit obligation, change in plan
assets, and funded status were:
(millions) 2003 2002
- ---------------------------------------------------------------------------------------
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation at beginning of year $ 2,261.4 $2,038.7
Acquisition adjustment - (13.4)
Service cost 67.5 57.0
Interest cost 151.1 140.7
Plan participants' contributions 1.7 1.2
Amendments 15.4 28.3
Actuarial loss 195.8 97.8
Benefits paid (134.9) (137.2)
Foreign currency adjustments 82.7 46.2
Other .2 2.1
- ---------------------------------------------------------------------------------------
Projected benefit obligation at end of year $2,640.9 $2,261.4
=======================================================================================
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $1,849.5 $1,845.3
Acquisition adjustment - (21.4)
Actual return on plan assets 456.9 (191.3)
Employer contributions 82.4 309.3
Plan participants' contributions 1.7 1.2
Benefits paid (132.3) (133.7)
Foreign currency adjustments 61.0 39.9
Other - .2
- ---------------------------------------------------------------------------------------
Fair value of plan assets at end of year $2,319.2 $1,849.5
=======================================================================================
FUNDED STATUS ($ 321.7) ($ 411.9)
Unrecognized net loss 822.3 846.7
Unrecognized transition amount 2.4 2.3
Unrecognized prior service cost 54.4 51.8
- ---------------------------------------------------------------------------------------
Prepaid pension $ 557.4 $ 488.9
=======================================================================================
AMOUNTS RECOGNIZED IN THE CONSOLIDATED
BALANCE SHEET CONSIST OF
Prepaid benefit cost $ 388.1 $ 364.2
Accrued benefit liability (256.3) (376.1)
Intangible asset 28.0 27.5
Minimum pension liability 397.6 473.3
- ---------------------------------------------------------------------------------------
Net amount recognized $ 557.4 $ 488.9
=======================================================================================
The accumulated benefit obligation for all defined benefit pension plans
was $2.41 billion and $2.05 billion at December 27, 2003 and December 28,
2002, respectively. The projected benefit obligation, accumulated benefit
obligation, and fair value of plan assets for pension plans with
accumulated benefit obligations in excess of plan assets were:
(millions) 2003 2002
- --------------------------------------------------------------------
Projected benefit obligation $ 1,590.4 $ 1,779.4
Accumulated benefit obligation 1,394.6 1,569.1
Fair value of plan assets 1,220.0 1,340.6
====================================================================
At December 27, 2003, a cumulative after-tax charge of $271.3 million
($397.6 million pretax) has been recorded in other comprehensive income to
recognize the additional minimum pension liability in excess of
unrecognized prior service cost. Refer to Note 5 for further information on
the changes in minimum liability included in other comprehensive income for
each of the periods presented.
Kellogg
Company
43
EXPENSE
The components of pension expense were:
(millions) 2003 2002 2001
- --------------------------------------------------------------------------------------------
Service cost $ 67.5 $ 57.0 $ 47.4
Interest cost 151.1 140.7 124.5
Expected return on plan assets (224.3) (217.5) (192.4)
Amortization of unrecognized
transition obligation .1 .3 .3
Amortization of unrecognized
prior service cost 7.3 6.9 6.6
Recognized net (gain) loss 28.6 11.5 4.6
Curtailment and special termination benefits -
net (gain) loss 8.1 -- (1.5)
- --------------------------------------------------------------------------------------------
Pension expense (income) - Company plans 38.4 (1.1) (10.5)
Pension expense - defined contribution plans 3.2 2.9 3.0
- --------------------------------------------------------------------------------------------
Total pension expense (income) $ 41.6 $ 1.8 $ (7.5)
============================================================================================
Certain of the Company's subsidiaries sponsor 401(k) or similar savings
plans for active employees. Expense related to these plans was (in
millions): 2003-$26; 2002-$26; 2001-$25. Company contributions to these
savings plans approximate annual expense. Company contributions to
multiemployer and other defined contribution pension plans approximate the
amount of annual expense presented in the table above.
All gains and losses, other than those related to curtailment or special
termination benefits, are recognized over the average remaining service
period of active plan participants. Net losses from special termination
benefits recognized in 2003 are related primarily to a plant workforce
reduction in Great Britain. Net gains from curtailment and special
termination benefits recognized in 2001 were recorded as a component of
restructuring charges. Refer to Note 3 for further information.
ASSUMPTIONS
The worldwide weighted average actuarial assumptions used to determine
benefit obligations were:
2003 2002 2001
- --------------------------------------------------------------------------
Discount rate 5.9% 6.6% 7.0%
Long-term rate of compensation increase 4.3% 4.7% 4.7%
==========================================================================
The worldwide weighted average actuarial assumptions used to determine
annual net periodic benefit cost were:
2003 2002 2001
- -------------------------------------------------------------------------------------
Discount rate 6.6% 7.0% 7.0%
Long-term rate of compensation increase 4.7% 4.7% 4.6%
Long-term rate of return on plan assets 9.3% 10.5% 10.4%
=====================================================================================
To determine the overall expected long-term rate of return on plan assets,
the Company works with third party financial consultants to model expected
returns over a 20-year investment horizon with respect to the specific
investment mix of its major plans. The return assumptions used reflect a
combination of rigorous historical performance analysis and forward-looking
views of the financial markets including consideration of current yields on
long-term bonds, price-earnings ratios of the major stock market indices,
and long-term inflation. The model currently incorporates a long-term
inflation assumption of 2.5% and an active management premium of 1% (net of
fees) validated by historical analysis. Although management reviews the
Company's expected long-term rates of return annually, the benefit trust
investment performance for one particular year does not, by itself,
significantly influence this evaluation. The expected rates of return are
generally not revised, provided these rates continue to fall within a "more
likely than not" corridor of between the 25th and 75th percentile of
expected long-term returns, as determined by the Company's modeling
process. The current expected rate of return of 9.3% presently equates to
approximately the 50th percentile expectation. Any future variance between
the expected and actual rates of return on plan assets is recognized in the
calculated value of plan assets over a five-year period and once
recognized, experience gains and losses are amortized using a
declining-balance method over the average remaining service period of
active plan participants.
PLAN ASSETS
The Company's year-end pension plan weighted-average asset allocations by
asset category were:
2003 2002
- -------------------------------------------------
Equity securities 74.6% 75.5%
Debt securities 24.3% 23.7%
Other 1.1% .8%
- ------------------------------------------------
Total 100.0% 100.0%
================================================
The Company's investment strategy for its major defined benefit plans is to
maintain a diversified portfolio of asset classes with the primary goal of
meeting long-term cash requirements as they become due. Assets are invested
in a prudent manner to maintain the security of funds while maximizing
returns within the Company's guidelines. The current weighted-average
target asset allocation reflected by this strategy is: equity
securities-78.2%; debt securities-21.1%; other-.7%. Investment in Company
common stock represented 1.7% and 2.0% of consolidated plan assets at
December 27, 2003 and December 28, 2002, respectively. Plan funding
strategies are influenced by tax regulations. The Company currently expects
to contribute approximately $83 million to its defined benefit pension
plans during 2004.
NOTE 10
NONPENSION POSTRETIREMENT
AND POSTEMPLOYMENT BENEFITS
POSTRETIREMENT
The Company sponsors a number of plans to provide health care and other
welfare benefits to retired employees in the United States and Canada, who
have met certain age and service requirements. The majority of these plans
are funded or unfunded defined benefit plans, although the Company does
participate in a few multiemployer or other defined contribution plans for
certain em-
Earning
Our
Stripes
44
ployee groups. The Company contributes to voluntary employee benefit
association (VEBA) trusts to fund certain U.S. retiree health and welfare
benefit obligations. The Company uses its fiscal year-end as the
measurement date for these plans.
OBLIGATIONS AND FUNDED STATUS
The aggregate change in accumulated postretirement benefit obligation,
change in plan assets, and funded status were:
(millions) 2003 2002
- ------------------------------------------------------------------------------------------------------------
CHANGE IN ACCUMULATED BENEFIT OBLIGATION
Accumulated benefit obligation at beginning of year $ 908.6 $ 895.2
Acquisition adjustment -- (2.2)
Service cost 12.5 11.9
Interest cost 60.4 60.3
Actuarial loss 78.4 90.2
Amendments (5.9) (97.3)
Benefits paid (51.4) (50.4)
Foreign currency adjustments 3.4 .4
Other .6 .5
- ------------------------------------------------------------------------------------------------------------
Accumulated benefit obligation at end of year $1,006.6 $ 908.6
- ------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 280.4 $ 212.6
Actual return on plan assets 69.6 (27.5)
Employer contributions 101.8 137.3
Benefits paid (50.1) (42.5)
Other .5 .5
- ------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 402.2 $ 280.4
- ------------------------------------------------------------------------------------------------------------
FUNDED STATUS ($ 604.4) ($ 628.2)
Unrecognized net loss 295.6 265.6
Unrecognized prior service cost (32.0) (28.7)
- ------------------------------------------------------------------------------------------------------------
Accrued postretirement benefit cost recognized as a liability ($ 340.8) ($ 391.3)
============================================================================================================
EXPENSE
Components of postretirement benefit expense were:
(millions) 2003 2002 2001
- ---------------------------------------------------------------------------------------------------
Service cost $12.5 $ 11.9 $ 10.7
Interest cost 60.4 60.3 49.7
Expected return on plan assets (32.8) (26.8) (24.5)
Amortization of unrecognized prior service cost (2.5) (2.3) (1.1)
Recognized net (gains) losses 12.3 9.2 (2.3)
Curtailment and special termination
benefits - net gain -- (16.9) (.2)
- ---------------------------------------------------------------------------------------------------
Postretirement benefit expense $49.9 $ 35.4 $ 32.3
===================================================================================================
All gains and losses, other than those related to curtailment or special
termination benefits, are recognized over the average remaining service
period of active plan participants. During 2002, the Company recognized a
$16.9 million curtailment gain related to a change in certain retiree
health care benefits from employer-provided defined benefit plans to
multiemployer defined contribution plans. Net gains from curtailment and
special termination benefits recognized in 2001 were recorded as a
component of restructuring charges. Refer to Note 3 for further
information.
ASSUMPTIONS
The weighted average actuarial assumptions used to determine benefit
obligations were:
2003 2002 2001
- -----------------------------------------------------------
Discount rate 6.0% 6.9% 7.3%
===========================================================
The weighted average actuarial assumptions used to determine annual net
periodic benefit cost were:
2003 2002 2001
- ----------------------------------------------------------------------------------
Discount rate 6.9% 7.3% 7.5%
Long-term rate of return on plan assets 9.3% 10.5% 10.5%
==================================================================================
The Company determines the overall expected long-term rate of return on
VEBA trust assets in the same manner as that described for pension trusts
in Note 9.
The assumed health care cost trend rate is 8.5% for 2004, decreasing
gradually to 4.5% by the year 2008 and remaining at that level thereafter.
These trend rates reflect the Company's recent historical experience and
management's expectation that future rates will continue to decline. A
one-percentage point change in assumed health care cost trend rates would
have the following effects:
ONE PERCENTAGE ONE PERCENTAGE
(millions) POINT INCREASE POINT DECREASE
- --------------------------------------------------------------------------------------------
Effect on total of service and interest cost components $ 9.5 ($ 8.2)
Effect on postretirement benefit obligation $ 118.2 ($ 101.0)
========================================================================================
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare Part D, as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a
benefit that is at least actuarially equivalent to Medicare Part D. As
permitted by FASB FSP 106-1, management has elected to defer recognition of
the effects of the Act in accounting for and making disclosures for the
Company's postretirement benefit plans until authoritative guidance is
issued. Refer to Note 1 for further information.
Kellogg
Company
45
PLAN ASSETS
The Company's year-end VEBA trust weighted-average asset allocations by
asset category were:
2003 2002
- ---------------------------------------------
Equity securities 66% 44%
Debt securities 21% 19%
Other 13% 37%
- ---------------------------------------------
Total 100% 100%
=============================================
The Company's asset investment strategy for its VEBA trusts is consistent
with that described for its pension trusts in Note 9. The current target
asset allocation is 80% equity securities and 20% debt securities. Actual
asset allocations at year-end 2003 and 2002 differ significantly from the
target due to late-year cash contributions not yet invested. The Company
currently expects to contribute approximately $67 million to its VEBA
trusts during 2004.
POSTEMPLOYMENT
Under certain conditions, the Company provides benefits to former or
inactive employees in the United States and several foreign locations,
including salary continuance, severance, and long-term disability. The
Company recognizes an obligation for any of these benefits that vest or
accumulate with service. Postemployment benefits that do not vest or
accumulate with service (such as severance based solely on annual pay
rather than years of service) or costs arising from actions that offer
benefits to employees in excess of those specified in the respective plans
are charged to expense when incurred. The Company's postemployment benefit
plans are unfunded. Actuarial assumptions used are consistent with those
presented for postretirement benefits above. The aggregate change in
accumulated postemployment benefit obligation and the net amount recognized
were:
(millions) 2003 2002
- --------------------------------------------------------------------------------
CHANGE IN ACCUMULATED BENEFIT OBLIGATION
Accumulated benefit obligation at beginning of year $27.1 $35.6
Service cost 3.0 2.0
Interest cost 2.0 1.7
Actuarial loss 11.3 (6.9)
Benefits paid (9.2) (5.5)
Foreign currency adjustments .8 .2
- --------------------------------------------------------------------------------
Accumulated benefit obligation at end of year $35.0 $27.1
- --------------------------------------------------------------------------------
FUNDED STATUS ($35.0) ($27.1)
Unrecognized net loss 11.8 3.7
- --------------------------------------------------------------------------------
Accrued postemployment benefit cost recognized as
a liability ($23.2) ($23.4)
================================================================================
Components of postemployment benefit expense were:
(millions) 2003 2002 2001
- --------------------------------------------------------------------------
Service cost $ 3.0 $ 2.0 $ 1.8
Interest cost 2.0 1.7 1.9
Recognized net losses 3.0 1.4 .9
- --------------------------------------------------------------------------
Postemployment benefit expense $ 8.0 $ 5.1 $ 4.6
==========================================================================
NOTE 11 INCOME TAXES
Earnings before income taxes and cumulative effect of accounting change,
and the provision for U.S. federal, state, and foreign taxes on these
earnings, were:
(millions) 2003 2002 2001 (a)
- -----------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES
AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE
United States $ 799.9 $ 791.3 $ 452.6
Foreign 369.6 353.0 339.9
- -----------------------------------------------------------------------------------
$1,169.5 $1,144.3 $ 792.5
- -----------------------------------------------------------------------------------
INCOME TAXES
Currently payable:
Federal $ 141.9 $ 157.1 $ 116.8
State 40.5 46.2 30.0
Foreign 125.2 108.9 99.6
- -----------------------------------------------------------------------------------
307.6 312.2 246.4
- -----------------------------------------------------------------------------------
Deferred:
Federal 91.7 82.8 53.1
State (8.6) 8.4 1.2
Foreign (8.3) 20.0 17.2
- -----------------------------------------------------------------------------------
74.8 111.2 71.5
- -----------------------------------------------------------------------------------
Total income taxes $ 382.4 $ 423.4 $ 317.9
===================================================================================
(a) Results for 2001 have been restated to reflect the adoption of SFAS No. 145
in 2003 concerning the income statement classification of losses from debt
extinguishment. The net loss incurred in 2001, which was originally
classified as an extraordinary loss, has been reclassified as follows (in
millions): Earnings before income taxes and cumulative effect of accounting
change reduced by $11.6; Income taxes currently payable reduced by $4.2.
Refer to Note 1 for further information.
The difference between the U.S. federal statutory tax rate and the
Company's effective rate was:
2003 2002 2001
- -------------------------------------------------------------------------------------------
U.S. statutory rate 35.0% 35.0% 35.0%
Foreign rates varying from 35% -.9 -.8 -1.1
State income taxes, net of federal benefit 1.8 3.1 2.5
Foreign earnings repatriation -- 2.8 --
Donation of appreciated assets -- -1.5 --
Net change in valuation allowances -.1 -.2 .1
Nondeductible goodwill amortization -- -- 2.9
Statutory rate changes, deferred tax impact -.1 -- -.1
Other -3.0 -1.4 .8
- -------------------------------------------------------------------------------------------
Effective income tax rate 32.7% 37.0% 40.1%
===========================================================================================
The effective income tax rate for 2001 of approximately 40% reflected the
impact of the Keebler acquisition (refer to Note 2) on nondeductible
goodwill and the level of U.S. tax on foreign subsidiary earnings. As a
result of the Company's adoption of SFAS No. 142 on January 1, 2002 (refer
to Note 1), goodwill amortization expense - and the resulting impact on the
effective income tax rate - has been eliminated in periods subsequent to
adoption. Accordingly, the 2002 effective income tax rate was reduced to
37%. Due primarily to the implementation of various tax planning
initiatives and audit closures, the 2003 effective income tax rate was
lowered to 32.7%, which includes over 200 basis points of single-event
benefits such as revaluation of deferred state tax liabilities.
Earning
Our
Stripes
46
Generally, the changes in valuation allowances on deferred tax assets and
corresponding impacts on the effective income tax rate, as presented in the
table above, result from management's assessment of the Company's ability
to utilize certain operating loss and tax credit carryforwards. Total tax
benefits of carryforwards at year-end 2003 and 2002 were approximately $40
million and $21 million, respectively. Of the total carryforwards at
year-end 2003, approximately $6 million expire during 2004 and another $26
million expire within five years. Based on management's assessment of the
Company's ability to utilize these benefits prior to expiration, the
carrying value of deferred tax assets associated with carryforwards was
reduced by valuation allowances to approximately $10 million at December
27, 2003.
The deferred tax assets and liabilities included in the balance sheet at
year end were:
Deferred tax assets Deferred tax liabilities
- -----------------------------------------------------------------------------------------------------------------
(millions) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------
Current:
Promotion and advertising $ 19.0 $ 21.2 $ 8.0 $ 7.6
Wages and payroll taxes 39.9 30.3 -- --
Inventory valuation 18.0 14.3 16.0 16.5
Health and postretirement benefits 41.2 53.9 -- .1
State taxes 12.4 17.2 -- --
Operating loss and credit carryforwards 1.0 .2 -- --
Deferred intercompany revenue -- 42.6 5.0 7.5
Keebler exit liabilities 3.0 6.7 -- --
Unrealized hedging losses, net 31.2 29.0 .1 .1
Other 31.5 31.1 6.0 5.7
- -----------------------------------------------------------------------------------------------------------------
197.2 246.5 35.1 37.5
Less valuation allowance (3.2) (2.6) -- --
- -----------------------------------------------------------------------------------------------------------------
194.0 243.9 35.1 37.5
=================================================================================================================
Noncurrent:
Depreciation and asset disposals 10.2 9.2 365.4 348.3
Health and postretirement benefits 238.9 282.3 223.1 187.2
Capitalized interest -- -- 12.6 17.2
State taxes -- -- 74.8 88.3
Operating loss and credit carryforwards 39.1 20.9 -- --
Trademarks and other intangibles -- -- 665.7 665.2
Deferred compensation 39.8 41.9 -- --
Other 11.3 21.8 6.5 10.5
- -----------------------------------------------------------------------------------------------------------------
339.3 376.1 1,348.1 1,316.7
Less valuation allowance (33.6) (32.1) -- --
- -----------------------------------------------------------------------------------------------------------------
305.7 344.0 1,348.1 1,316.7
- -----------------------------------------------------------------------------------------------------------------
Total deferred taxes $ 499.7 $ 587.9 $1,383.2 $1,354.2
=================================================================================================================
At December 27, 2003, foreign subsidiary earnings of approximately $1.09
billion were considered permanently invested in those businesses.
Accordingly, U.S. income taxes have not been provided on these earnings.
Cash paid for income taxes was (in millions): 2003-$289; 2002-$250;
2001-$196. The 2001 amount is net of a tax refund of approximately $73
million related to the cash-out of Keebler employee and director stock
options upon acquisition of Keebler Foods Company.
NOTE 12 FINANCIAL INSTRUMENTS AND CREDIT RISK CONCENTRATION
The fair values of the Company's financial instruments are based on
carrying value in the case of short-term items, quoted market prices for
derivatives and investments, and, in the case of long-term debt,
incremental borrowing rates currently available on loans with similar terms
and maturities. The carrying amounts of the Company's cash, cash
equivalents, receivables, and notes payable approximate fair value. The
fair value of the Company's long-term debt at December 27, 2003, exceeded
its carrying value by approximately $499 million.
The Company is exposed to certain market risks which exist as a part of its
ongoing business operations and uses derivative financial and commodity
instruments, where appropriate, to manage these risks. In general,
instruments used as hedges must be effective at reducing the risk
associated with the exposure being hedged and must be designated as a hedge
at the inception of the contract. In accordance with SFAS No. 133 (refer to
Note 1), the Company designates derivatives as either cash flow hedges,
fair value hedges, net investment hedges, or other contracts used to reduce
volatility in the translation of foreign currency earnings to U.S. Dollars.
The fair values of all hedges are recorded in accounts receivable or other
current liabilities. Gains and losses representing either hedge
ineffectiveness, hedge components excluded from the assessment of
effectiveness, or hedges of translational exposure are recorded in other
income (expense), net.
CASH FLOW HEDGES
Qualifying derivatives are accounted for as cash flow hedges when the
hedged item is a forecasted transaction. Gains and losses on these
instruments are recorded in other comprehensive income until the underlying
transaction is recorded in earnings. When the hedged item is realized,
gains or losses are reclassified from accumulated other comprehensive
income to the Statement of Earnings on the same line item as the underlying
transaction. For all cash flow hedges, gains and losses representing either
hedge ineffectiveness or hedge components excluded from the assessment of
effectiveness were insignificant during the periods presented.
The total net loss attributable to cash flow hedges recorded in accumulated
other comprehensive income at December 27, 2003, was $51.9 million, related
primarily to forward-starting interest rate swaps settled during 2001
(refer to Note 7). This loss is being reclassified into interest expense
over periods of 5 to 30 years. Other insignificant amounts related to
foreign currency and commodity price cash flow hedges will be reclassified
into earnings during the next 18 months.
FAIR VALUE HEDGES
Qualifying derivatives are accounted for as fair value hedges when the
hedged item is a recognized asset, liability, or firm commit-
Kellogg
Company
47
ment. Gains and losses on these instruments are recorded in earnings,
offsetting gains and losses on the hedged item. For all fair value hedges,
gains and losses representing either hedge ineffectiveness or hedge
components excluded from the assessment of effectiveness were insignificant
during the periods presented.
NET INVESTMENT HEDGES
Qualifying derivative and nonderivative financial instruments are accounted
for as net investment hedges when the hedged item is a foreign currency
investment in a subsidiary. Gains and losses on these instruments are
recorded as a foreign currency translation adjustment in other
comprehensive income.
OTHER CONTRACTS
The Company also enters into foreign currency forward contracts and options
to reduce volatility in the translation of foreign currency earnings to
U.S. Dollars. Gains and losses on these instruments are recorded in other
income (expense), net, generally reducing the exposure to translation
volatility during a full-year period.
FOREIGN EXCHANGE RISK
The Company is exposed to fluctuations in foreign currency cash flows
related primarily to third-party purchases, intercompany loans and product
shipments, and nonfunctional currency denominated third party debt. The
Company is also exposed to fluctuations in the value of foreign currency
investments in subsidiaries and cash flows related to repatriation of these
investments. Additionally, the Company is exposed to volatility in the
translation of foreign currency earnings to U.S. Dollars. The Company
assesses foreign currency risk based on transactional cash flows and
translational positions and enters into forward contracts, options, and
currency swaps to reduce fluctuations in net long or short currency
positions. Forward contracts and options are generally less than 18 months
duration. Currency swap agreements are established in conjunction with the
term of underlying debt issues.
For foreign currency cash flow and fair value hedges, the assessment of
effectiveness is generally based on changes in spot rates. Changes in time
value are reported in other income (expense), net.
INTEREST RATE RISK
The Company is exposed to interest rate volatility with regard to future
issuances of fixed rate debt and existing issuances of variable rate debt.
The Company currently uses interest rate swaps, including forward-starting
swaps, to reduce interest rate volatility and funding costs associated with
certain debt issues, and to achieve a desired proportion of variable versus
fixed rate debt, based on current and projected market conditions.
Variable-to-fixed interest rate swaps are accounted for as cash flow hedges
and the assessment of effectiveness is based on changes in the present
value of interest payments on the underlying debt. Fixed-to-variable
interest rate swaps are accounted for as fair value hedges and the
assessment of effectiveness is based on changes in the fair value of the
underlying debt, using incremental borrowing rates currently available on
loans with similar terms and maturities.
PRICE RISK
The Company is exposed to price fluctuations primarily as a result of
anticipated purchases of raw and packaging materials. The Company uses the
combination of long cash positions with suppliers, and exchange-traded
futures and option contracts to reduce price fluctuations in a desired
percentage of forecasted purchases over a duration of generally less than
18 months.
Commodity contracts are accounted for as cash flow hedges. The assessment
of effectiveness is based on changes in futures prices.
CREDIT RISK CONCENTRATION
The Company is exposed to credit loss in the event of nonperformance by
counterparties on derivative financial and commodity contracts. This credit
loss is limited to the cost of replacing these contracts at current market
rates. Management believes the probability of such loss is remote.
Financial instruments, which potentially subject the Company to
concentrations of credit risk, are primarily cash, cash equivalents, and
accounts receivable. The Company places its investments in highly rated
financial institutions and investment-grade short-term debt instruments,
and limits the amount of credit exposure to any one entity. Historically,
concentrations of credit risk with respect to accounts receivable have been
limited due to the large number of customers, generally short payment
terms, and their dispersion across geographic areas. However, there has
been significant worldwide consolidation in the grocery industry in recent
years. At December 27, 2003, the Company's five largest customers globally
comprised approximately 20% of consolidated accounts receivable.
NOTE 13 QUARTERLY FINANCIAL DATA (UNAUDITED)
(millions, except
per share data) Net sales Gross profit
- ------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------
First $2,147.5 $2,061.8 $ 916.4 $ 884.6
Second 2,247.4 2,125.1 1,015.3 963.6
Third 2,281.6 2,136.5 1,034.0 973.1
Fourth 2,135.0 1,980.7 946.9 913.8
- ------------------------------------------------------------------------------
$8,811.5 $8,304.1 $3,912.6 $3,735.1
==============================================================================
Net earnings Net earnings per share
- ------------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------
Basic Diluted Basic Diluted
----------------------------------------------------------
First $ 163.9 $ 152.6 $ .40 $ .40 $ .37 $ .37
Second 203.9 173.8 .50 .50 .42 .42
Third 231.3 203.5 .57 .56 .50 .49
Fourth 188.0 191.0 .46 .46 .47 .47
- ------------------------------------------------------------------------------------------------------------
$ 787.1 $ 720.9
============================================================================================================
Earning
Our
Stripes
48
The principal market for trading Kellogg shares is the New York Stock
Exchange (NYSE). The shares are also traded on the Boston, Chicago,
Cincinnati, Pacific, and Philadelphia Stock Exchanges. At year-end 2003,
the closing price (on the NYSE) was $37.80 and there were 44,635
shareholders of record.
Dividends paid per share and the quarterly price ranges on the NYSE during
the last two years were:
Stock price
Dividend --------------------------
2003 - QUARTER per share High Low
- -----------------------------------------------------------
First $ .2525 $ 34.96 $ 28.02
Second .2525 35.36 30.46
Third .2525 35.04 33.06
Fourth .2525 37.80 32.92
- -----------------------------------------------------------
$ 1.0100
===========================================================
2002 - Quarter
First $ .2525 $ 34.95 $ 29.35
Second .2525 36.89 32.75
Third .2525 35.63 30.00
Fourth .2525 36.06 31.81
- -----------------------------------------------------------
$ 1.0100
===========================================================
NOTE 14 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, and meat alternatives. Kellogg
products are manufactured and marketed globally. 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. Thus, the
Company's reportable operating segments under SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information" consist of the
United States, Europe, and Latin America. All other geographic areas have
been combined under the quantitative threshold guidelines of SFAS No. 131
for purposes of the information presented below. While this historical
organizational structure is the basis of the operating segment data
presented in this report, we recently reorganized our geographic management
structure to North America, Europe, Latin America, and Asia Pacific, and we
will begin reporting on this basis for 2004.
The measurement of operating segment results is generally consistent with
the presentation of the Consolidated Statement of Earnings and Balance
Sheet. Intercompany transactions between reportable operating segments were
insignificant in all periods presented.
(millions) 2003 2002 2001
- ----------------------------------------------------------------------------------------
NET SALES
United States $ 5,629.3 $ 5,525.4 $ 4,889.4
Europe 1,734.2 1,469.8 1,360.7
Latin America 645.7 631.1 650.0
All other operating
segments 802.3 677.8 648.3
- ----------------------------------------------------------------------------------------
Consolidated $ 8,811.5 $ 8,304.1 $ 7,548.4
========================================================================================
SEGMENT OPERATING PROFIT
United States $ 1,055.0 $ 1,073.0 $ 875.5
Europe 279.8 252.5 245.6
Latin America 168.5 170.1 171.1
All other operating
segments 140.0 104.0 103.1
Corporate (99.2) (91.5) (90.5)
- ----------------------------------------------------------------------------------------
Consolidated $ 1,544.1 $ 1,508.1 $ 1,304.8
Amortization eliminated
by SFAS No. 142 (b) -- -- (103.6)
Restructuring charges (a) -- -- (33.3)
- ----------------------------------------------------------------------------------------
Operating profit as
reported $ 1,544.1 $ 1,508.1 $ 1,167.9
========================================================================================
RESTRUCTURING CHARGES (A)
United States $ -- $ -- $ 29.5
Europe -- -- (.2)
Latin America -- -- (.1)
All other operating -- -- 1.4
segments
Corporate -- -- 2.7
- ----------------------------------------------------------------------------------------
Consolidated $ -- $ -- $ 33.3
========================================================================================
DEPRECIATION AND
AMORTIZATION
United States $ 238.2 $ 221.2 $ 275.9
Europe 71.1 65.7 59.5
Latin America 21.6 17.1 21.7
All other operating
segments 28.2 30.0 31.4
Corporate 13.7 15.9 50.1
- ----------------------------------------------------------------------------------------
Consolidated $ 372.8 $ 349.9 $ 438.6
========================================================================================
INTEREST EXPENSE
United States $ 1.0 $ 3.3 $ 5.7
Europe 18.2 22.3 2.9
Latin America .2 .6 2.8
All other operating
segments 3.3 3.4 1.5
Corporate 348.7 361.6 338.6
- ----------------------------------------------------------------------------------------
Consolidated $ 371.4 $ 391.2 $ 351.5
========================================================================================
INCOME TAXES EXCLUDING
CHARGES (A)
United States $ 325.0 $ 349.8 $ 235.5
Europe 54.6 46.3 54.4
Latin America 40.0 42.5 40.3
All other operating
segments 23.3 22.2 18.1
Corporate (60.5) (37.4) (17.6)
- ----------------------------------------------------------------------------------------
Consolidated $ 382.4 $ 423.4 $ 330.7
Effect of charges -- -- (12.8)
- ----------------------------------------------------------------------------------------
Income taxes as reported $ 382.4 $ 423.4 $ 317.9
========================================================================================
TOTAL ASSETS
United States $10,061.4 $ 9,784.7 $ 9,634.4
Europe 1,801.7 1,687.3 1,801.0
Latin America 341.2 337.4 415.5
All other operating
segments 620.8 554.0 681.2
Corporate 6,362.3 6,112.1 5,697.6
Elimination entries (8,956.6) (8,256.2) (7,861.1)
- ----------------------------------------------------------------------------------------
Consolidated $10,230.8 $10,219.3 $10,368.6
========================================================================================
(a) Refer to Note 3 for further information on restructuring charges.
(b) Pro forma impact of amorization eliminated by SFAS No. 142. Refer to
Note 1 for further information.
Kellogg
Company
49
(millions) 2003 2002 2001
- -----------------------------------------------------------------------------
ADDITIONS TO LONG-LIVED ASSETS
United States $ 180.4 $ 197.4 $5,601.2
Europe 35.5 33.4 43.8
Latin America 15.4 13.6 11.7
All other operating segments 15.3 10.1 10.8
Corporate .6 1.2 29.5
- -----------------------------------------------------------------------------
Consolidated $ 247.2 $ 255.7 $5,697.0
=============================================================================
The Company's largest customer,Wal-Mart Stores, Inc. and its affiliates,
accounted for approximately 13% of consolidated net sales during 2003, 12% in
2002, and 11% in 2001, comprised principally of sales within the United States.
Supplemental geographic information is provided below for net sales to external
customers and long-lived assets:
(millions) 2003 2002 2001
- -----------------------------------------------------------------------------
NET SALES
United States $5,629.3 $5,525.4 $4,889.4
United Kingdom 740.2 667.4 622.8
Other foreign countries 2,442.0 2,111.3 2,036.2
- -----------------------------------------------------------------------------
Consolidated $8,811.5 $8,304.1 $7,548.4
=============================================================================
LONG-LIVED ASSETS
United States $7,350.5 $7,434.2 $7,275.9
United Kingdom 435.1 423.5 526.6
Other foreign countries 627.6 584.6 651.5
- -----------------------------------------------------------------------------
Consolidated $8,413.2 $8,442.3 $8,454.0
=============================================================================
Supplemental product information is provided below for net sales to external
customers:
(millions) 2003 2002 2001
- -----------------------------------------------------------------------------
United States
Retail channel cereal $2,086.6 $1,951.6 $1,840.4
Retail channel snacks 2,134.9 2,206.4 1,922.7
Other 1,407.8 1,367.4 1,126.3
International
Cereal 2,801.6 2,476.9 2,381.5
Convenience foods 380.6 301.8 277.5
- -----------------------------------------------------------------------------
Consolidated $8,811.5 $8,304.1 $7,548.4
=============================================================================
NOTE 15 SUPPLEMENTAL FINANCIAL STATEMENT DATA
(millions)
CONSOLIDATED STATEMENT OF EARNINGS 2003 2002 2001
- -----------------------------------------------------------------------------
Research and development expense $ 126.7 $ 106.4 $ 110.2
Advertising expense $ 698.9 $ 588.7 $ 519.2
=============================================================================
CONSOLIDATED STATEMENT OF CASH FLOWS 2003 2002 2001
- --------------------------------------------------------------------------------------
Accounts receivable ($ 17.9) $ 28.1 $ 100.9
Inventories (48.2) (26.4) 15.8
Other current assets .4 70.7 (5.0)
Accounts payable 84.8 41.3 47.6
Other current liabilities 25.3 83.8 111.6
- --------------------------------------------------------------------------------------
CHANGES IN OPERATING ASSETS AND LIABILITIES $ 44.4 $ 197.5 $ 270.9
======================================================================================
(millions)
CONSOLIDATED BALANCE SHEET 2003 2002
- ---------------------------------------------------------------------------
Trade receivables $ 716.8 $ 681.0
Allowance for doubtful accounts (15.1) (16.0)
Other receivables 53.1 76.0
- ---------------------------------------------------------------------------
ACCOUNTS RECEIVABLE, NET $ 754.8 $ 741.0
- ---------------------------------------------------------------------------
Raw materials and supplies $ 185.3 $ 172.2
Finished goods and materials in process 464.5 431.0
- ---------------------------------------------------------------------------
INVENTORIES $ 649.8 $ 603.2
- ---------------------------------------------------------------------------
Deferred income taxes $ 150.0 $ 207.8
Other prepaid assets 101.4 110.8
- ---------------------------------------------------------------------------
OTHER CURRENT ASSETS $ 251.4 $ 318.6
- ---------------------------------------------------------------------------
Land $ 75.1 $ 62.6
Buildings 1,417.5 1,345.6
Machinery and equipment 4,555.3 4,284.8
Construction in progress 171.6 159.6
Accumulated depreciation (3,439.3) (3,012.4)
- ---------------------------------------------------------------------------
PROPERTY, NET $ 2,780.2 $ 2,840.2
- ---------------------------------------------------------------------------
Goodwill $ 3,098.4 $ 3,106.6
Other intangibles 2,069.5 2,069.1
Accumulated amortization (35.1) (22.1)
Other 520.6 462.1
- ---------------------------------------------------------------------------
OTHER ASSETS $ 5,653.4 $ 5,615.7
- ---------------------------------------------------------------------------
Accrued income taxes $ 143.0 $ 151.7
Accrued salaries and wages 261.1 228.0
Accrued advertising and promotion 323.1 309.0
Accrued interest 108.3 123.2
Other 327.8 386.7
- ---------------------------------------------------------------------------
OTHER CURRENT LIABILITIES $ 1,163.3 $ 1,198.6
- ---------------------------------------------------------------------------
Nonpension postretirement benefits $ 291.0 $ 329.6
Deferred income taxes 1,062.8 986.4
Other 402.4 473.9
- ---------------------------------------------------------------------------
OTHER LIABILITIES $ 1,756.2 $ 1,789.9
===========================================================================
(millions)
============================================================================
INTANGIBLE ASSETS SUBJECT TO AMORTIZATION
- ----------------------------------------------------------------------------
Gross carrying amount Accumulated amortization
- ----------------------------------------------------------------------------
2003 2002 2003 2002
- -------------------------------------------------------------------------
Trademarks $ 29.5 $ 29.5 $ 18.3 $ 17.2
Other 29.1 29.2 16.8 4.9
- -------------------------------------------------------------------------
Total $ 58.6 $ 58.7 $ 35.1 $ 22.1
============================================================================
2003 (b) 2002
============================================================================
AMORTIZATION EXPENSE (a) $ 13.0 $ 3.0
- ----------------------------------------------------------------------------
(a) The currently estimated aggregate amortization expense for each of the 5
succeeding fiscal years is approximately $3 per year.
(b) Amortization for 2003 includes an impairment loss of $10. Refer to Note 3
for further information.
(millions)
===========================================================================
INTANGIBLE ASSETS NOT SUBJECT TO AMORTIZATION
- ---------------------------------------------------------------------------
Total carrying amount
- ---------------------------------------------------------------------------
2003 2002
- ---------------------------------------------------------------------------
Trademarks $ 1,404.0 $ 1,404.0
Direct store door (DSD) delivery system 578.9 578.9
Other 28.0 27.5
- ---------------------------------------------------------------------------
Total $ 2,010.9 $ 2,010.4
===========================================================================
Earning
Our
Stripes
50
CHANGES IN THE CARRYING AMOUNT OF GOODWILL
- -----------------------------------------------------------------------------------------------
Latin Consoli-
(millions) United States Europe America Other (b) dated
- -----------------------------------------------------------------------------------------------
January 1, 2002 $3,065.0 -- $ 3.1 $ 1.4 $3,069.5
SFAS No. 142 reclassification (a) 46.3 -- -- -- 46.3
Purchase accounting adjustments 22.2 -- -- -- 22.2
Dispositions (30.3) -- -- -- (30.3)
Foreign currency remeasurement
impact and other -- -- (1.1) -- (1.1)
- -----------------------------------------------------------------------------------------------
December 28, 2002 $3,103.2 -- $ 2.0 $ 1.4 $3,106.6
Purchase accounting adjustments (4.2) -- -- -- (4.2)
Dispositions (5.0) -- -- -- (5.0)
Foreign currency remeasurement
impact and other (.2) -- .5 .7 1.0
- -----------------------------------------------------------------------------------------------
DECEMBER 27, 2003 $3,093.8 -- $ 2.5 $ 2.1 $3,098.4
===============================================================================================
(a) Assembled workforce intangible no longer meets separability criteria under
SFAS No. 142 and has been reclassified to goodwill effective January 1,
2002.
(b) Other operating segments include Australia, Asia, and Canada.
As discussed in Note 1, the Company adopted SFAS No. 142 "Goodwill and Other
Intangible Assets" on January 1, 2002. The provisions of SFAS No. 142 are
adopted prospectively and prior-period financial statements are not restated.
Comparative earnings information for 2001 is presented in the following table:
(millions, except per share data) 2003 2002 2001 (a)
- --------------------------------------------------------------------------------------
NET EARNINGS
Originally reported $ 787.1 $ 720.9 $ 473.6
Goodwill amortization -- -- 59.0
Intangibles no longer amortized -- -- 26.0
- --------------------------------------------------------------------------------------
Total amortization $ -- $ -- $ 85.0
- --------------------------------------------------------------------------------------
Comparable $ 787.1 $ 720.9 $ 558.6
======================================================================================
NET EARNINGS PER SHARE - BASIC
Originally reported $ 1.93 $ 1.77 $ 1.17
Goodwill amortization -- -- .15
Intangibles no longer amortized -- -- .06
- --------------------------------------------------------------------------------------
Total amortization $ -- $ -- $ .21
- --------------------------------------------------------------------------------------
Comparable $ 1.93 $ 1.77 $ 1.38
======================================================================================
NET EARNINGS PER SHARE - DILUTED
Originally reported $ 1.92 $ 1.75 $ 1.16
Goodwill amortization -- -- .15
Intangibles no longer amortized -- -- .06
- --------------------------------------------------------------------------------------
Total amortization $ -- $ -- $ .21
- --------------------------------------------------------------------------------------
Comparable $ 1.92 $ 1.75 $ 1.37
======================================================================================
(a) Results for 2001 have been restated to reflect the adoption of SFAS No. 145
in 2003 concerning the income statement classification of losses from debt
extinguishment. The net loss of $7.4 incurred in 2001, which was originally
classified as an extraordinary loss, has been reclassified to Earnings
before cumulative effect of accounting change. After this reclassification,
Earnings before cumulative effect of accounting change was not materially
different from Net earnings. Refer to Note 1 for further information.
Kellogg
Company
51
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of Kellogg Company is responsible for the reliability of the
consolidated financial statements and related notes. The financial statements
were prepared in conformity with accounting principles that are generally
accepted in the United States, using our best estimates and judgements as
required.
We maintain a system of internal controls designed to provide reasonable
assurance of the reliability of the financial statements, as well as to
safeguard assets from unauthorized use or disposition. Formal policies and
procedures, including an active Ethics and Business Conduct program, support the
internal controls, and are designed to ensure employees adhere to the highest
standards of personal and professional integrity. We have established a vigorous
internal audit program that independently evaluates the adequacy and
effectiveness of these internal controls.
The Audit Committee of the Board of Directors meets regularly with management,
internal auditors, and independent auditors to review internal control,
auditing, and financial reporting matters. Both our independent auditors and
internal auditors have free access to the Audit Committee.
We believe these consolidated financial statements do not misstate or omit any
material facts. Our formal certification to the Securities and Exchange
Commission is made with our Annual Report on Form 10-K.
The independent auditing firm of PricewaterhouseCoopers LLP was retained to
audit our consolidated financial statements and their report follows.
/s/ C. M. Gutierrez
C. M. Gutierrez
Chairman of the Board
Chief Executive Officer
/s/ J. A. Bryant
J. A. Bryant
Executive Vice President
Chief Financial Officer
/s/ J. M. Boromisa
J. M. Boromisa
Senior Vice President
Chief Accounting Officer
REPORT OF INDEPENDENT AUDITORS
PRICEWATERHOUSECOOPERS LLP
To the Shareholders and Board of Directors of Kellogg Company
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Kellogg
Company and its subsidiaries at December 27, 2003 and December 28, 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 27, 2003 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for goodwill and other intangible assets in
conformity with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" which was adopted as of January 1, 2002.
/S/ PricewaterhouseCoopers LLP
Battle Creek, Michigan
January 28, 2004
Earning
Our
Stripes
52