1
EXHIBIT 13.01
Selected Financial Data
(millions, except per share data and number of employees)
- --------------------------------------------------------------------------------------------------------------------------
(a)(b)
Earnings
(a) before Average
Net % Operating % accounting % shares
sales Growth profit Growth change Growth outstanding(c)
- --------------------------------------------------------------------------------------------------------------------------
10-year
compound
growth rate 5% 1% -
1998 $ 6,762.1 <1%> $ 895.1 <11%> $ 502.6 <11%> 407.8
1997 6,830.1 2 1,009.1 5 564.0 6 414.1
1996 6,676.6 (5) 958.9 14 531.0 8 424.9
1995 7,003.7 7 837.5 (28) 490.3 (30) 438.3
1994 6,562.0 4 1,162.6 16 705.4 4 448.6
1993 6,295.4 2 1,004.6 (5) 680.7 - 463.0
1992 6,190.6 7 1,062.8 3 682.8 13 477.7
1991 5,786.6 12 1,027.9 16 606.0 21 482.4
1990 5,181.4 11 886.0 21 502.8 19 483.2
1989 4,651.7 7 732.5 (8) 422.1 (12) 488.4
1988 4,348.8 15 794.1 15 480.4 21 492.8
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Per Common Share Data (c)
----------------------------------------------------------
(a)(b) Net cash
Earnings (d) Net cash provided by/
before Price/ Stock provided by (used in) Common
accounting Cash earnings price operating financing stock
change dividends ratio range activities activities repurchases
- -------------------------------------------------------------------------------------------------------------------------------
10-year
compound
growth rate 2% 9%
1998 $ 1.23 $ 0.92 28 $30 - 50 $ 719.7 $(358.3) $ 239.7
1997 1.36 0.87 36 32 - 50 879.8 (607.3) 426.0
1996 1.25 0.81 26 31 - 40 711.5 94.0 535.7
1995 1.12 0.75 34 26 - 40 1,041.0 (759.2) 374.7
1994 1.57 0.70 18 24 - 30 966.8 (559.5) 327.3
1993 1.47 0.66 19 23 - 34 800.2 (464.2) 548.1
1992 1.43 0.60 23 27 - 37 741.9 (422.6) 224.1
1991 1.26 0.54 26 17 - 33 934.4 (537.7) 83.6
1990 1.04 0.48 18 14 - 19 819.2 (490.9) 86.9
1989 0.87 0.43 20 14 - 20 533.5 (143.2) 78.6
1988 0.98 0.38 16 12 - 17 492.3 52.1 33.6
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Return on Return on
Total average Shareholders' average Property, Capital Depreciation Long-term
assets assets equity equity net expenditures and amortization debt
- ------------------------------------------------------------------------------------------------------------------------------------
1998 $ 5,051.5 10% $ 889.8 53% $ 2,888.8 $ 373.9 $ 278.1 $1,614.5
1997 4,877.6 11 997.5 49 2,773.3 312.4 287.3 1,415.4
1996 5,050.0 11 1,282.4 37 2,932.9 307.3 251.5 726.7
1995 4,414.6 11 1,590.9 29 2,784.8 315.7 258.8 717.8
1994 4,467.3 16 1,807.5 40 2,892.8 354.3 256.1 719.2
1993 4,237.1 16 1,713.4 37 2,768.4 449.7 265.2 521.6
1992 4,015.0 11 1,945.2 21 2,662.7 473.6 231.5 314.9
1991 3,925.8 16 2,159.8 30 2,646.5 333.5 222.8 15.2
1990 3,749.4 14 1,901.8 28 2,595.4 320.5 200.2 295.6
1989 3,390.4 14 1,634.4 30 2,406.3 508.7 167.6 371.4
1988 3,297.9 16 1,483.2 36 2,131.9 538.1 139.7 272.1
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(e) Pretax
Debt to interest
market coverage Current Advertising R&D Number of
capitalization (times) ratio expense expense employees
- ------------------------------------------------------------------------------------------------------------------
1998 16% 7 0.9 $ 695.3 $ 121.9 14,498
1997 10 9 0.9 780.4 106.1 14,339
1996 14 13 0.7 778.9 84.3 14,511
1995 5 12 1.1 891.5 72.2 14,487
1994 8 23 1.2 856.9 71.7 15,657
1993 7 27 1.0 772.4 59.2 16,151
1992 3 33 1.2 782.3 56.7 16,551
1991 3 17 0.9 708.3 34.7 17,017
1990 7 10 0.9 648.5 38.3 17,239
1989 10 10 0.9 611.4 42.9 17,268
1988 9 14 0.9 560.9 42.0 17,461
- ------------------------------------------------------------------------------------------------------------------
(a) Operating profit for 1998 includes non-recurring charges of $70.5 ($46.3
after tax or $.12 per share). Operating profit for 1997 includes
non-recurring charges of $184.1 ($140.5 after tax or $.34 per share).
Operating profit for 1996 includes non-recurring charges of $136.1 ($97.8
after tax or $.23 per share). Earnings before accounting change for 1996
include a charge of $35.0 ($22.3 after tax or $.05 per share) for a
contribution to the Kellogg's Corporate Citizenship Fund. Operating profit
for 1995 includes non-recurring charges of $421.8 ($271.3 after tax or $.62
per share). Operating profit for 1993 includes non-recurring charges of
$64.3 ($41.1 after tax or $.09 per share). Refer to Management's Discussion
and Analysis on pages 16-21 and Notes 3 and 4 within the Notes to
Consolidated Financial Statements for further explanation of non-recurring
charges and other unusual items for years 1996 - 1998.
(b) Earnings before accounting change for 1997 exclude the effect of a charge
of $18.0 after tax ($.04 per share) to write off business process
reengineering costs in accordance with guidance issued by the Emerging
Issues Task Force of the FASB. Earnings before accounting change for 1992
and 1989 exclude the effect of adopting the following Statements of
Financial Accounting Standards (SFAS): in 1992, a charge of $251.6 ($.53
per share) net of $144.6 of income tax benefit for the transition effect of
SFAS #106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," and, in 1989, a gain of $48.1 ($.10 per share) for SFAS #96
"Accounting for Income Taxes."
(c) All share data retroactively restated to reflect 2-for-1 stock splits in
1997 and 1991. All earnings per share data represent both basic and diluted
earnings per share.
(d) The price/earnings ratio was calculated based on year-end stock price
divided by earnings before the accounting changes referred to in note (b).
These earnings include the non-recurring charges and other unusual items
referred to in note (a). Excluding the impact of these unusual items, the
price/earnings ratio in 1998, 1997, 1996, 1995, and 1993 would have been
25, 29, 21, 22, and 19, respectively.
(e) Debt to market capitalization was calculated based on year-end total debt
balance divided by market capitalization. Market capitalization was
calculated based on year-end stock price multiplied by the number of shares
outstanding at year-end.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
KELLOGG COMPANY AND SUBSIDIARIES
RESULTS OF OPERATIONS
OVERVIEW
Kellogg Company manufactures and markets ready-to-eat cereal and other
grain-based convenience food products, including toaster pastries, frozen
waffles, cereal bars, and bagels, throughout the world. Principal markets for
these products include the United States and Great Britain. Operations are
managed via four major geographic areas - North America, Europe, Asia-Pacific,
and Latin America - which are the basis of the Company's reportable operating
segment information. The Company leads the global ready-to-eat cereal category
with an estimated 38% annualized share of worldwide volume. Additionally, the
Company is the North American market leader in the toaster pastry,
cereal/granola bar, frozen waffle, and pre-packaged bagel categories.
During 1998, the Company realized declines in earnings per share both with and
without unusual items (discussed below). The Company experienced significant
competitive pressure combined with category softness in its major ready-to-eat
cereal markets, to which it responded by accelerating investment in long-term
growth strategies, including product development, technology, and efficiency
initiatives.
For the full year of 1998, Kellogg Company reported net earnings and earnings
per share of $502.6 million and $1.23, respectively, compared to 1997 net
earnings of $546.0 million and net earnings per share of $1.32. Net earnings and
earnings per share for 1996 were $531.0 million and $1.25, respectively. (All
per share amounts reflect the 2-for-1 stock split effective August 22, 1997. All
earnings per share presented represent both basic and diluted earnings per
share.)
During the current and prior years, the Company reported non-recurring charges
and other unusual items that have been excluded from all applicable amounts
presented below for purposes of comparison between years. Additionally, results
for 1997 are presented before the cumulative effect of a change in the method of
accounting for business process reengineering costs. Refer to the separate
section below on non-recurring charges and other unusual items for further
information.
1998 compared to 1997
Excluding non-recurring charges and other unusual items, the Company reported
1998 earnings per share of $1.35, a 21% decrease from the prior-year result of
$1.70. The year-to-year decrease in earnings per share of $.35 resulted from
$.33 of business decline, $.01 of unfavorable tax rate movements, and $.03 of
unfavorable foreign currency movements, partially offset by a $.02 benefit from
share repurchase. The business decline was principally attributable to cereal
category softness and competitive pressures in North America and Europe, and
continued global investments in brand-building marketing activities and
streamlining initiatives. Foreign currency movements had a minimal net impact in
Europe and negatively impacted earnings by 2% on a consolidated basis due to
currency devaluation in Latin America and Asia-Pacific.
The Company realized the following volume results during 1998:
- ---------------------------------------------------------------
CHANGE
North America -4.3%
3
Europe -1.2%
Asia-Pacific +6.9%
Latin America +16.2%
- ---------------------------------------------------------------
Global total -1.3%
===============================================================
CHANGE
Global cereal -2.0%
Global convenience foods +1.1%
- ---------------------------------------------------------------
Global total -1.3%
===============================================================
Within North America and Europe, volume declines were principally due to
softness in the ready-to-eat cereal business. Asia-Pacific experienced record
volume due to a combination of cereal growth and new convenience food product
introductions. Latin America continued to post double-digit increases in both
ready-to-eat cereal and convenience foods, with record volume results throughout
1998.
The global convenience foods volume increase was driven by double-digit growth
in the Company's international markets offset by softness within North America,
primarily due to declines in the Lender's Bagels business.
On an annualized basis, regional volume market share of the ready-to-eat cereal
category was approximately 33% in North America, 43% in Europe, 43% in
Asia-Pacific, and 61% in Latin America.
Consolidated net sales decreased 1% for 1998. Adjusted for unfavorable foreign
currency translation, sales were even with the prior year, with the unfavorable
impact of volume declines offset by favorable pricing and product mix movements.
On an operating segment basis, net sales versus the prior year were:
==================================================================================================================
North Asia- Latin
America Europe Pacific America Consolidated
- ------------------------------------------------------------------------------------------------------------------
Business -1% - + 7% +16% -
Foreign currency impact -1% - -15% -4% -1%
- ------------------------------------------------------------------------------------------------------------------
TOTAL CHANGE -2% - -8% +12% -1%
==================================================================================================================
Margin performance for 1998 and 1997 was:
======================================================================================
1998 1997 CHANGE
- --------------------------------------------------------------------------------------
Gross margin +51.5% +52.1% - .6%
SGA%(a) -37.2% -34.6% -2.6%
- --------------------------------------------------------------------------------------
Operating margin +14.3% +17.5% -3.2%
======================================================================================
(a) Selling, general and administration expense as a percentage of net sales.
The gross margin decline was due to a combination of the fixed cost absorption
impact of lower volumes combined with incremental costs related to launching new
products in Europe and North America. The increase in SGA% reflects increased
global research and development costs to support our ongoing innovation strategy
combined with significant marketing investment and increased spending on
streamlining initiatives.
Operating profit (loss) on an operating segment basis was:
4
====================================================================================================================================
North Asia- Latin Corporate
(millions) America Europe Pacific America and other Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
1998 operating profit (loss) as reported $790.8 $208.1 $44.9 $107.2 ($255.9) $ 895.1
Non-recurring charges 40.8 3.3 3.4 - 23.0 70.5
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1998 OPERATING PROFIT (LOSS) EXCLUDING
NON-RECURRING CHARGES $831.6 $211.4 $48.3 $107.2 ($232.9) $ 965.6
====================================================================================================================================
1997 operating profit (loss) as reported $847.0 $189.9 $22.5 $111.6 ($161.9) $ 1,009.1
Non-recurring charges 37.8 115.9 28.6 .2 1.6 184.1
- ------------------------------------------------------------------------------------------------------------------------------------
1997 OPERATING PROFIT (LOSS) EXCLUDING
NON-RECURRING CHARGES $884.8 $305.8 $51.1 $111.8 ($160.3) $ 1,193.2
====================================================================================================================================
% change - 1998 vs. 1997 excluding non-recurring charges
Business -6% -31% +11% -1% -45% -18%
Foreign currency impact - - -16% -3% - -1%
====================================================================================================================================
TOTAL CHANGE -6% -31% -5% -4% -45% -19%
====================================================================================================================================
Gross interest expense, prior to amounts capitalized, increased 8% versus the
prior year to $127.3 million. The higher interest expense resulted from overall
increased debt levels, partially offset by a lower effective interest rate.
Excluding the impact of non-recurring charges and other unusual items, the
effective income tax rate was 35.7%, an increase of .4 percentage points versus
the prior-year rate. The higher effective tax rate is primarily due to lower
earnings and country mix. For both 1998 and 1997, the effective tax rate
benefited from statutory rate reductions in the United Kingdom, as well as
favorable adjustments in other jurisdictions. The effective income tax rate
based on reported earnings (before cumulative effect of accounting change) was
35.8% in 1998 and 37.6% in 1997.
1997 COMPARED TO 1996
Excluding non-recurring charges and other unusual items, the Company reported
1997 earnings per share of $1.70, an 11% increase over the prior-year results of
$1.53. The year-over-year increase in earnings per share of $.17 resulted from
$.12 of business growth, $.03 of common stock repurchases, and $.04 of favorable
tax rate movements, partially offset by $.02 of unfavorable foreign currency
movements. The business growth was principally attributable to cereal volume
growth in North America and Latin America, continued double-digit growth in
convenience foods volume, and reductions in manufacturing and marketing costs.
Foreign currency movements negatively impacted earnings 1% on a consolidated
basis. The negative impact of the Lender's Bagels business, acquired in December
1996, was approximately $.05.
The Company achieved the following volume growth during 1997:
=============================================================
CHANGE
North America +16.1%
Europe +2.6%
Asia-Pacific +1.5%
Latin America +16.3%
=============================================================
5
- -------------------------------------------------------------
Global total(a) +11.3%
- -------------------------------------------------------------
- -------------------------------------------------------------
CHANGE
Global cereal +3.4%
Global convenience foods(b) +47.2%
- -------------------------------------------------------------
Global total +11.3%
- -------------------------------------------------------------
(a) Excluding Lenders, acquired in December 1996, global volume growth was 5.0%.
(b) Excluding Lenders, global convenience foods growth was 12.5%.
Within North America, the Company recovered cereal volume declines of the prior
year, and slightly exceeded 1995 results. Growth in Europe was partially offset
by a decline in the United Kingdom, while Asia-Pacific was slowed by softness in
Australia. Latin America achieved record annual volume results.
Consolidated net sales increased 2% for 1997. The favorable impact of strong
volumes was partially offset by unfavorable pricing and product mix movements,
and a negative foreign currency impact of 2%. Excluding the Lender's business,
consolidated net sales were even with the prior year. On an operating segment
basis, net sales versus the prior year were:
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North Asia- Latin
America Europe Pacific America Consolidated
- ---------------------------------------------------------------------------------------------------------------------------
Business +4% +2% +2% +13% +4%
Foreign currency impact - -5% -7% -1% -2%
- ---------------------------------------------------------------------------------------------------------------------------
Total Change +4% -3% -5% +12% +2%
- ---------------------------------------------------------------------------------------------------------------------------
Margin performance for 1997 and 1996 was:
- ----------------------------------------------------------------------------------------
1997 1996 CHANGE
- ----------------------------------------------------------------------------------------
Gross margin +52.1% +53.2% -1.1%
SGA%(a) -34.6% -36.8% +2.2%
- ----------------------------------------------------------------------------------------
Operating margin +17.5% +16.4% +1.1%
- ----------------------------------------------------------------------------------------
(a) Selling, general and administration expense as a percentage of net sales.
Gross margin performance for 1997 benefited from volume increases and
year-over-year operational cost savings. However, these favorable factors were
outweighed by the negative impact of prior-year pricing actions. The reduction
in SGA% primarily reflects reduced promotional spending in North America.
Operating profit (loss) on an operating segment basis was:
- --------------------------------------------------------------------------------------------------------------------------------
North Asia- Latin Corporate
(millions) America Europe Pacific America and other Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
1997 operating profit (loss) excluding
non-recurring charges $884.8 $305.8 $51.1 $111.8 ($160.3) $1,193.2
- --------------------------------------------------------------------------------------------------------------------------------
1996 operating profit (loss) as reported $751.2 $249.8 $31.2 $93.5 ($166.8) $958.9
Non-recurring charges 11.1 55.3 30.1 .7 38.9 136.1
- --------------------------------------------------------------------------------------------------------------------------------
6
1996 operating profit (loss) excluding
non-recurring charges $762.3 $305.1 $61.3 $94.2 ($127.9) $1,095.0
- --------------------------------------------------------------------------------------------------------------------------------
% change - 1997 vs. 1996 excluding
non-recurring charges
Business +16% +4% -9% +20% -25% +11%
Foreign currency impact -- -4% -8% -1% -- -2%
- --------------------------------------------------------------------------------------------------------------------------------
Total change +16% +0% -17% +19% -25% +9%
- --------------------------------------------------------------------------------------------------------------------------------
Gross interest expense, prior to amounts capitalized, increased 70% versus the
prior year to $117.9 million. The higher interest expense resulted from
increased debt levels to fund the Lender's Bagels business acquisition and the
Company's common stock repurchase program.
Excluding the impact of non-recurring charges and other unusual items, the
effective income tax rate was 35.3%, 1.5 percentage points lower than the
prior-year rate. The lower effective tax rate is primarily due to enactment of a
2% statutory rate reduction in the United Kingdom, effective April 1, 1997, as
well as favorable adjustments in other jurisdictions. The effective income tax
rate based on reported earnings (before cumulative effect of accounting change)
was 37.6% in 1997 and 38.2% in 1996. For both 1997 and 1996, the higher reported
rate (as compared to the rate excluding the impact of unusual items) primarily
relates to certain non-recurring charges for which no tax benefit was provided,
based on management's assessment of the likelihood of recovering such benefit in
future years.
Other expense for 1996 included a charge of $35.0 million for a contribution to
the Kellogg's Corporate Citizenship Fund, a private trust established for
charitable donations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial condition remained strong throughout 1998. A strong cash
flow, combined with a program of issuing commercial paper and maintaining
worldwide credit facilities, provides adequate liquidity to meet the Company's
operational needs. In August 1998, Moody's lowered its rating on the Company's
senior unsecured notes from Aa1 to Aa2 reflecting the Company's increased use of
cash for investments in marketing, product development, and other initiatives in
highly competitive markets around the world. Management believes that this
change will have an insignificant impact on future borrowing costs. The rating
agency confirmed the Company's Prime-1 commercial paper rating.
Net cash provided by operating activities was $719.7 million during 1998,
compared to $879.8 million in 1997, with the decrease due principally to lower
earnings and unfavorable working capital movements. The ratio of current assets
to current liabilities was .9 at December 31, 1998, and 1997.
Net cash used in investing activities was $398.0 million, compared to 329.3
million in 1997. The increase was primarily due to property additions, which
increased from $312.4 million in 1997 to $373.9 million for 1998.
Net cash used in financing activities was $358.3 million, primarily related to
common stock repurchases of $239.7 million and dividend payments of $375.3
million, partially offset by a net
7
increase in total debt of $241.5 million. The Company's total 1998 per share
dividend payment was $.92, a 5.7% increase over the prior-year payment of $.87.
On August 1, 1997, the Company's Board of Directors approved a 2-for-1 stock
split to shareholders of record at the close of business August 8, 1997,
effective August 22, 1997, and also authorized retirement of 105.3 million
common shares (pre-split) held in treasury. All per share and shares outstanding
data have been restated retroactively to reflect the stock split.
Under existing plans authorized by the Company's Board of Directors, management
spent $239.7 million during 1998 to repurchase 6.3 million shares of the
Company's common stock at an average price of $38 per share. The open repurchase
authorization, which has been extended through December 31, 1999, was $149.4
million at year-end 1998.
Notes payable primarily consist of commercial paper borrowings in the United
States and borrowings under a $200 million revolving credit agreement in Europe
with several international banks initiated during December 1998. At December 31,
1998, outstanding borrowings under the revolving credit agreement were $148.5
million with an effective interest rate of 5.5%. U.S. borrowings at December 31,
1998, were $423.3 million with an effective interest rate of 5.2%. Associated
with the U.S. borrowings, during September 1997, the Company purchased a $225
million notional, four-year fixed interest rate cap. Under the terms of the cap,
if the Federal Reserve AA composite rate on 30-day commercial paper increases to
6.33%, the Company will pay this fixed rate on $225 million of its commercial
paper borrowings. If the rate increases to 7.68% or above, the cap will expire.
As of year-end 1998, the rate was 4.90%.
In October 1998, the Company issued $200 million of seven-year 4.875% fixed rate
U.S. Dollar Notes. Management used the proceeds from this issuance to replace
maturing long-term debt. Management entered into a series of interest rate
hedges throughout 1998 to effectively fix the interest rate prior to issuance.
The effect of the hedges, when combined with original issue discounts, resulted
in an overall effective rate for this debt of 6.07%.
To reduce short-term borrowings, on February 4, 1998, the Company issued $400
million of three-year 5.75% fixed rate U.S. Dollar Notes. Accordingly, an
equivalent amount of commercial paper borrowings was classified as long-term
debt in the December 31, 1997, balance sheet. These Notes were issued under an
existing "shelf registration" with the Securities and Exchange Commission, and
provide an option to holders to extend the obligation for an additional four
years at a predetermined interest rate of 5.63% plus the Company's then-current
credit spread. As a result of this option, the effective interest rate on the
three-year Notes is 5.23%. Concurrent with this issuance, the Company entered
into a $400 million notional, three-year fixed-to-floating interest rate swap,
indexed to the Federal Reserve AA composite rate on 30-day commercial paper.
On January 29, 1997, the Company issued $500 million of seven-year 6.625% fixed
rate Euro Dollar Notes. This debt was issued primarily to fund the purchase of
the Lender's Bagels business, acquired in December 1996. In conjunction with
this issuance, the Company settled $500 million notional amount of interest rate
forward swap agreements, which effectively fixed the interest rate on the debt
at 6.354%. Associated with this debt, during September 1997, the
8
Company entered into a $225 million notional, 4 1/2-year fixed-to-floating
interest rate swap, indexed to the three-month London Interbank Offered Rate
(LIBOR). Under the terms of this swap, if three-month LIBOR decreases to 4.71%
or below, the swap will expire. At year-end 1998, three-month LIBOR was 5.07%.
To replace other long-term debt maturing during 1997, the Company issued $500
million of four-year 6.125% Euro Dollar Notes on August 5, 1997. In conjunction
with this issuance, the Company settled $400 million notional amount of interest
rate forward swap agreements that effectively fixed the interest rate on the
debt at 6.4%. Associated with this debt, during September 1997, the Company
entered into a $200 million notional, four-year fixed-to-floating interest rate
swap, indexed to three-month LIBOR.
The ratio of total debt to market capitalization at December 31, 1998, was 16%,
up from 10% at December 31, 1997, due to a combination of a lower stock price
and higher debt levels in 1998.
NON-RECURRING CHARGES AND OTHER UNUSUAL ITEMS
From 1995 to the present, management has commenced major productivity and
operational streamlining initiatives in an effort to optimize the Company's cost
structure. The incremental costs of these programs have been reported throughout
1995-1998 as non-recurring charges.
In addition to the non-recurring charges reported for streamlining initiatives,
the Company incurred charges for other unusual items. Furthermore, net earnings
for 1997 included a cumulative effect of accounting change related to business
process reengineering costs. In summary, the following charges were excluded
from reported results for purposes of comparison within the "Results of
operations" section above:
- --------------------------------------------------------------------------------------------------------------
NON-RECURRING CHARGES & OTHER UNUSUAL ITEMS
- --------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE NET
Impact on (millions, except per OPERATING INCOME TAXES & NET EARNINGS PER
share data) PROFIT CUMULATIVE EFFECT EARNINGS SHARE
OF ACCOUNTING
CHANGE
----------------------------------------------------------------------------------------------------------
1998
----------------------------------------------------------------------------------------------------------
STREAMLINING
INITIATIVES $70.5 $70.5 $46.3 $.12
----------------------------------------------------------------------------------------------------------
1997
----------------------------------------------------------------------------------------------------------
Streamlining
initiatives $161.1 $161.1
Impairment losses 23.0 23.0
----------------------------------------------------------------------------------------------------------
TOTAL NON-RECURRING
CHARGES $184.1 $184.1 $140.5 $.34
9
EARNINGS BEFORE NET
Impact on (millions, except per OPERATING INCOME TAXES & NET EARNINGS PER
share data) PROFIT CUMULATIVE EFFECT EARNINGS SHARE
OF ACCOUNTING
CHANGE
----------------------------------------------------------------------------------------------------------
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE $ 18.0 $.04
----------------------------------------------------------------------------------------------------------
1996
----------------------------------------------------------------------------------------------------------
Streamlining
initiatives $121.1 $121.1
Litigation provision 15.0 15.0
Private trust contribution(a) -- 35.0
----------------------------------------------------------------------------------------------------------
TOTAL $136.1 $171.1 $120.1 $.28
----------------------------------------------------------------------------------------------------------
(a) Recorded in other income (expense), net.
The 1998 streamlining charges relate primarily to an overhead activity analysis
that resulted in the elimination of approximately 550 employees and 240
contractors from the Company's headquarters and North American operations
through a combination of involuntary early retirement and severance programs.
The charges consist mainly of employee retirement and separation benefits,
outplacement services, associated consulting and other related costs. This
initiative is expected to result in annual pre-tax savings of $105 million,
beginning in 1999. Cash outlays for the 1998 charges during 1998 were $8
million, with the remainder to be spent during 1999. Total cash outlays during
1998 for all streamlining initiatives were approximately $47 million. Refer to
Note 3 within Notes to Consolidated Financial Statements for further
information.
All streamlining programs commenced since 1995, including the aforementioned
1998 initiatives, are expected to result in the elimination of approximately
3,500 employee positions by the end of 1999, with approximately 95% of this
reduction already achieved. These programs are expected to deliver average
annual pre-tax savings in excess of $300 million by the year 2000, with
approximately $250 million of that amount to be realized in 1999. These savings
are not necessarily indicative of current and future incremental earnings due to
management's commitment to invest in competitive business strategies, new
markets, and growth opportunities.
In addition to the non-recurring charges reported during 1997 and 1996 for
streamlining initiatives, the Company incurred charges for the following unusual
items:
- - During 1997, the Company included in non-recurring charges $23.0 million of
asset impairment losses which resulted from an evaluation of the Company's
ability to recover components of its investments in the emerging markets of
Asia-Pacific.
10
- - During 1996, the Company included in non-recurring charges a provision of
$15.0 million for the potential settlement of certain litigation.
- - During 1996, the Company included in other expense a charge of $35.0 million
for a contribution to the Kellogg's Corporate Citizenship Fund, which is
expected to satisfy the charitable-giving plans of this private trust
through the year 2000.
The Company's streamlining initiatives will continue throughout 1999. The
aforementioned overhead activity analysis will be extended to Europe and Latin
America during the first half of 1999. Management believes these initiatives
will result in the elimination of several hundred employee positions, requiring
separation benefit costs to be incurred. Since the number of employees affected,
their job functions, and their locations have not yet been identified, the costs
that may result are not yet known. The combination of this Europe and Latin
America overhead activity analysis and other ongoing cost reduction programs is
expected to result in more than $50 million in incremental savings in 1999.
The foregoing discussion of streamlining initiatives contains forward-looking
statements regarding headcount reductions, cash requirements, and realizable
savings. Actual amounts may vary depending on the final determination of
important factors, such as identification of specific employees to be separated
from pre-determined pools, actual amounts of asset removal and relocation costs,
dates of asset disposal and costs to maintain assets up to the date of disposal,
proceeds from asset disposals, final negotiation of third party contract
buy-outs, and other items.
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AcSEC) issued Statement of Position
(SOP) 98-1 "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." SOP 98-1 provides guidance on the classification of software
project costs between expense and capital. During April 1998, AcSEC also issued
SOP 98-5 "Reporting on Costs of Start-up Activities." SOP 98-5 prescribes that
the costs of opening a new facility, commencing business in a new market, or
similar start-up activities must be expensed as incurred. Both of these
pronouncements are effective for fiscal years beginning after December 15, 1998.
SOP 98-1 is to be applied on a prospective basis to costs incurred on or after
the date of adoption. The initial application of SOP 98-5 is to be reported as a
cumulative effect of a change in accounting principle, if material. Management
intends to adopt SOP 98-1 and SOP 98-5 effective January 1, 1999, and does not
expect the impact of adoption to have a significant impact on the Company's
financial results.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) #133 "Accounting for Derivative
Instruments and Hedging Activities." This Statement establishes accounting and
reporting standards for derivative instruments, requiring recognition of the
fair value of all derivatives as assets or liabilities on the balance sheet.
SFAS #133 is effective for fiscal years beginning after June 15, 1999.
Management intends to adopt the provisions of SFAS #133 effective January 1,
11
2000, and does not expect the impact of adoption to have a significant impact on
the Company's financial results.
On November 20, 1997, the Emerging Issues Task Force (EITF) of the FASB reached
a consensus in EITF Issue 97-13 that the costs of business process reengineering
activities are to be expensed as incurred. This consensus also applies to
business process reengineering activities that are part of an information
technology project. Beginning in 1996, the Company has undertaken an Enterprise
Business Applications (EBA) initiative that combines design and installation of
business processes and software packages to achieve global best practices. Under
the EBA initiative, the Company had capitalized certain external costs
associated with business process reengineering activities as part of the
software asset. EITF Issue 97-13 prescribes that previously capitalized business
process reengineering costs should be expensed and reported as a cumulative
effect of a change in accounting principle. Accordingly, for the fourth quarter
of 1997, the Company reported a charge of $18.0 million (net of tax benefit of
$7.7 million) or $.04 per share for write-off of business process reengineering
costs. Such costs were expensed as incurred during 1998 and the fourth quarter
of 1997 and were insignificant.
YEAR 2000
The Company established a global program in 1997 to address the millennium date
change issue (the inability of certain computer software, hardware, and other
equipment with embedded computer chips to properly process two-digit year-date
codes after 1999). The program is structured to address all date-related risks
to the Company's business in four major categories: information technology
systems, embedded technology systems, suppliers, and customers.
In the information technology and embedded systems categories, the inventories
and detailed assessments are complete, remediation is 70% complete, and testing
is 50% complete. Remediation and testing are on schedule with planned completion
by June 30, 1999, for business critical and important systems.
The Company is spending approximately $70 million during 1998 and 1999 to become
Year 2000 compliant. This amount includes the costs of activities described
above, as well as costs to replace non-compliant systems for which replacement
was accelerated to meet Year 2000 requirements. On a global basis, spending
through December 31, 1998 is consistent with the overall percentage of program
completion of approximately 70%. These amounts do not include the effect of
other planned system initiatives that will contribute to the Year 2000
compliance effort. Management believes that to the extent these other planned
system initiatives impact the Year 2000 project, they will be completed as
scheduled by mid-1999.
The Company is continuing a contingency planning process started in 1998
designed to mitigate business risks due to unexpected date-related issues within
any of the Year 2000 program categories across all key business units worldwide.
The testing results for information technology and embedded systems are being
coupled with risk assessments of the Company's suppliers, customers, and other
internal initiatives, and incorporated into this contingency planning process.
These plans are expected to be defined in each of the Company's four operating
segments of
12
North America, Europe, Asia-Pacific, and Latin America by April of 1999, for
execution in preparation to the millennium transition.
While management believes that the estimated cost of becoming Year 2000
compliant is not significant to the Company's financial results, failure to
complete all the work in a timely manner could result in material financial
risk. While management expects all planned work to be completed, there can be no
guarantee that all systems will be in compliance by the year 2000, that the
systems of other companies and government agencies on which the Company relies
will be converted in a timely manner, or that contingency planning will be able
to fully address all potential interruptions. Therefore, date-related issues
could cause delays in the Company's ability to produce or ship its products,
process transactions, or otherwise conduct business in any of its markets.
EURO CONVERSION
On January 1, 1999, eleven European countries (Germany, France, Spain, Italy,
Ireland, Portugal, Finland, Luxembourg, Belgium, Austria, and the Netherlands)
implemented a single currency zone, the Economic and Monetary Union (EMU). The
new currency, the Euro, has become the official currency of the participating
countries. Those countries financial markets and banking systems are quoting
financial and treasury data in Euros from January 1, 1999.
The Euro will exist alongside the old national currencies during a transition
period from January 1, 1999 to January 1, 2002. During this period, entities
within participating countries must complete changes which enable them to
transact in the Euro. National currencies will be withdrawn no later than July
1, 2002. This transition to the Euro currency will involve changing budgetary,
accounting, pricing, costing, and fiscal systems in companies and public
administrations, as well as the simultaneous handling of parallel currencies and
conversion of legacy data. During the first quarter of 1999, the Euro currency
has demonstrated stability. However, this early stability needs to be observed
over a longer period before conclusions can be drawn on the currency's long-term
viability.
In early 1998, management formed a task force to monitor EMU developments,
evaluate the impact of the Euro conversion on the Company's operations, and
develop and execute action plans, as necessary. The task force has completed a
full EMU impact assessment identifying company-wide, cross-functional effects of
the Euro. Required business strategy, system, and process changes within the
Company's European region are underway with certain markets already Euro
compliant. Many of these changes will be made in conjunction with other
significant technology initiatives currently under way, and will be completed in
accordance with the Company's timetable for transacting with its suppliers and
customers in the Euro. Results of task force assessments indicate that most
suppliers and customers desire to initiate Euro transactions during 2000 and
2001.
Management expects to complete financial, operational, and manufacturing system
conversions during 2001. Although Management currently believes the Company will
be able to accommodate any required changes in its operations, there can be no
assurance that the Company, its
13
customers, suppliers, financial service providers, or government agencies will
meet all of the Euro currency requirements on a timely basis. Such failure to
complete the necessary work could result in material financial risk.
1999 OUTLOOK
Management is not aware of any adverse trends that would materially affect the
Company's strong financial position. Should suitable investment opportunities or
working capital needs arise that would require additional financing, management
believes that the Company's strong credit rating, balance sheet, and earnings
history provide a base for obtaining additional financial resources at
competitive rates and terms. Based on the expectation of cereal volume growth,
and strong results from product innovation and the continued global roll-out of
convenience foods, management believes the Company is well-positioned to deliver
sales and earnings growth for the full year 1999. The Company will continue to
identify and pursue streamlining and productivity initiatives to optimize its
cost structure.
The Company is currently reviewing strategies related to the Lender's Bagels
business, given its performance since acquisition. The Company has evaluated the
recoverability of Lender's long-lived assets as of December 31, 1998, and
although this evaluation has not resulted in the recognition of an impairment
loss, management expects to update its assessment during 1999.
Additional expectations for 1999 include a gross profit margin of 51-52%, an
SGA% of 36-37%, an effective income tax rate of 36-37%, and capital spending of
approximately $270 million.
The foregoing projections concerning impact of future borrowing costs,
accounting changes, volume growth, profitability, capital spending, and common
stock repurchase activity are forward-looking statements that involve risks and
uncertainties. Actual results may differ materially due to the impact of
competitive conditions, marketing spending and/or incremental pricing actions on
actual volumes and product mix; the levels of spending on system initiatives,
properties, business opportunities, continued streamlining initiatives, and
other general and administrative costs; raw material price and labor cost
fluctuations; foreign currency exchange rate fluctuations; changes in statutory
tax law; interest rates available on short-term financing; the impact of stock
market conditions on common stock repurchase activity; and other items.
14
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF EARNINGS
Year ended December 31,
===============================================================================================================================
(millions, except per share data) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
NET SALES $6,762.1 $6,830.1 $6,676.6
- -------------------------------------------------------------------------------------------------------------------------------
Costs of goods sold $3,282.6 3,270.1 3,122.9
Selling and administrative expense 2,513.9 2,366.8 2,458.7
Non-recurring charges 70.5 184.1 136.1
- -------------------------------------------------------------------------------------------------------------------------------
OPERATING PROFIT 895.1 1,009.1 958.9
- -------------------------------------------------------------------------------------------------------------------------------
Interest expense 119.5 108.3 65.6
Other income (expense), net 6.9 3.7 (33.4)
- -------------------------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 782.5 904.5 859.9
Income taxes 279.9 340.5 328.9
- -------------------------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 502.6 564.0 531.0
Cumulative effect of accounting change
(net of tax) -- (18.0) --
- -------------------------------------------------------------------------------------------------------------------------------
NET EARNINGS $ 502.6 $ 546.0 $ 531.0
- -------------------------------------------------------------------------------------------------------------------------------
PER SHARE AMOUNTS (BASIC AND DILUTED):
EARNINGS BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE $ 1.23 $ 1.36 $ 1.25
Cumulative effect of accounting change -- (.04) --
- -------------------------------------------------------------------------------------------------------------------------------
NET EARNINGS PER SHARE $ 1.23 $ 1.32 $ 1.25
===============================================================================================================================
Refer to Notes to Consolidated Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------------------------
Accumulated
Common stock Capital in Treasury stock other
------------ excess of Retained -------------- comprehensive
(millions) shares amount par value earnings shares amount income
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 1996 311.1 $77.8 $105.2 $3,963.0 94.4 ($2,361.2) ($193.9)
Common stock repurchases 7.4 (535.7)
Net earnings 531.0
Dividends (343.7)
Other comprehensive income 27.6
Stock options exercised and other 0.4 0.1 18.7 0.1 (6.5)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 311.5 77.9 123.9 4,150.3 101.9 (2,903.4) (166.3)
- ---------------------------------------------------------------------------------------------------------------------------------
Common stock repurchases (pre-split) 3.9 (290.9)
Stock options exercised and other (pre-split) 0.6 0.1 31.9 -- (3.9)
Retirement of treasury stock (105.3) (26.3) (55.8) (3,095.8) (105.3) 3,177.9
Two-for-one stock split 206.8 51.7 (51.7) 0.5 ------
Common stock repurchases (post-split) 3.1 (135.1)
Net earnings 546.0
Dividends (360.1)
Other comprehensive
income (115.6)
Stock options exercised and other (post-split) 1.2 0.3 44.3 -- (1.9)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 414.8 103.7 92.6 1,240.4 4.1 (157.3) (281.9)
- ---------------------------------------------------------------------------------------------------------------------------------
Common stock repurchases 6.3 (239.7)
Net earnings 502.6
Dividends (375.3)
Other comprehensive income (10.5)
Stock options exercised and other 0.5 0.1 12.4 (0.1) 2.7
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 415.3 $103.8 $105.0 $1,367.7 10.3 ($394.3) ($292.4)
- ---------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Total Total
shareholders' comprehensive
equity income
(millions)
- -----------------------------------------------------------------------------------
Balance, January 1, 1996 $1,590.9
Common stock repurchases (535.7)
Net earnings 531.0 $531.0
Dividends (343.7)
Other comprehensive income 27.6 27.6
Stock options exercised and other 12.3
- -----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 1,282.4 $558.6
- -----------------------------------------------------------------------------------
Common stock repurchases (pre-split) (290.9)
Stock options exercised and other (pre-split) 28.1
Retirement of treasury stock ------
Two-for-one stock split ------
Common stock repurchases (post-split) (135.1)
Net earnings 546.0 $546.0
Dividends (360.1)
Other comprehensive income (115.6) (115.6)
Stock options exercised and other (post-split) 42.7
- -----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 997.5 $430.4
- -----------------------------------------------------------------------------------
Common stock repurchases (239.7)
Net earnings 502.6 $502.6
Dividends (375.3)
Other comprehensive income (10.5) (10.5)
Stock options exercised and other 15.2
- -----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $889.8 $492.1
- -----------------------------------------------------------------------------------
Refer to Notes to Consolidated Financial Statements.
15
Kellogg Company and Subsidiaries
CONSOLIDATED BALANCE SHEET
At December 31,
===============================================================================================================================
(millions, except share data) 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and cash equivalents $136.4 $173.2
Accounts receivable, less allowances of $12.9 and $7.5 693.0 587.5
Inventories 451.4 434.3
Other current assets 215.7 272.7
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 1,496.5 1,467.7
- -------------------------------------------------------------------------------------------------------------------------------
PROPERTY, NET 2,888.8 2,773.3
OTHER ASSETS 666.2 636.6
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $5,051.5 $4,877.6
===============================================================================================================================
CURRENT LIABILITIES
Current maturities of long-term debt $1.1 $211.2
Notes payable 620.4 368.6
Accounts payable 386.9 328.0
Other current liabilities 710.1 749.5
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 1,718.5 1,657.3
- -------------------------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT 1,614.5 1,415.4
OTHER LIABILITIES 828.7 807.4
SHAREHOLDERS' EQUITY
Common stock, $.25 par value,500,000,000 shares authorized
Issued: 415,343,626 shares in 1998 and 414,823,142 in 1997 103.8 103.7
Capital in excess of par value 105.0 92.6
Retained earnings 1,367.7 1,240.4
Treasury stock, at cost:
10,346,524 shares in 1998 and 4,143,124 in 1997 (394.3) (157.3)
Accumulated other comprehensive income (292.4) (281.9)
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 889.8 997.5
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $5,051.5 $4,877.6
===============================================================================================================================
Refer to Notes to Consolidated Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended December 31,
==============================================================================================================================
(millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net earnings $ 502.6 $ 546.0 $ 531.0
Items in net earnings not requiring (providing) cash:
Depreciation and amortization 278.1 287.3 251.5
Deferred income taxes 46.2 38.5 58.0
Non-recurring charges, net of cash paid 62.2 133.8 90.6
Other 21.7 9.5 14.5
Pension and other postretirement benefit contributions (88.8) (114.5) (156.8)
Changes in operating assets and liabilities (102.3) (20.8) (77.3)
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 719.7 879.8 711.5
- ------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Additions to properties (373.9) (312.4) (307.3)
Acquisitions of businesses (27.8) (25.4) (505.2)
Property disposals 6.8 5.9 11.6
Other (3.1) 2.6 14.1
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (398.0) (329.3) (786.8)
- ------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net issuances (reductions) of notes payable,
with maturities less than or equal to 90 days (152.9) (374.7) 906.6
Issuances of notes payable, with maturities greater than 90 days 5.5 4.8 137.0
Reductions of notes payable, with maturities greater than 90 days (.8) (14.1) (79.0)
Issuances of long-term debt 600.0 1,000.0 --
Reductions of long-term debt (210.3) (507.9) (3.4)
Net issuances of common stock 15.2 70.7 12.2
Common stock repurchases (239.7) (426.0) (535.7)
Cash dividends (375.3) (360.1) (343.7)
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (358.3) (607.3) 94.0
- ------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (.2) (13.8) 3.2
- ------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (36.8) (70.6) 21.9
Cash and cash equivalents at beginning of year 173.2 243.8 221.9
- ------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 136.4 $ 173.2 $ 243.8
==============================================================================================================================
Refer to Notes to Consolidated Financial Statements.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Kellogg Company and Subsidiaries
NOTE 1 ACCOUNTING POLICIES
Consolidation
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.
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
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.
Goodwill and other intangible assets
Intangible assets are amortized principally 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. The realizability of goodwill
and other intangibles is evaluated periodically when events or circumstances
indicate a possible inability to recover the carrying amount. Evaluation is
based on various analyses, including cash flow and profitability projections.
Advertising
The costs of advertising are generally expensed as incurred.
Recently adopted pronouncements
In 1998, the Company adopted several statements issued by the Financial
Accounting Standards Board (FASB). In June 1997, the FASB issued Statement of
Financial Accounting Standards (SFAS) #130 "Reporting Comprehensive Income,"
which requires companies to disclose all items recognized under accounting
standards as components of comprehensive income. In June 1997, the FASB issued
SFAS #131 "Disclosures about Segments of an Enterprise and Related Information,"
which requires certain information to be reported about operating segments
consistent with management's internal view of the Company. In February 1998, the
FASB issued SFAS #132 "Employers' Disclosures
17
about Pensions and Other Postretirement Benefits," which revises and
standardizes disclosures for pension and other postretirement benefit plans.
On November 20, 1997, the Emerging Issues Task Force (EITF) of the FASB reached
a consensus in EITF 97-13 that the costs of business process reengineering
activities are to be expensed as incurred. This consensus also applies to
business process reengineering activities that are part of an information
technology project. Beginning in 1996, the Company has undertaken an Enterprise
Business Applications (EBA) initiative that combines design and installation of
business processes and software packages to achieve global best practices. Under
the EBA initiative, the Company had capitalized certain external costs
associated with business process reengineering activities as part of the
software asset. EITF Issue 97-13 prescribes that previously capitalized business
process reengineering costs should be expensed and reported as a cumulative
effect of a change in accounting principle. Accordingly, for the fourth quarter
of 1997, the Company reported a charge of $18.0 million (net of tax benefit of
$7.7 million) or $.04 per share for write-off of business process reengineering
costs. Such costs were expensed as incurred during 1998 and the fourth quarter
of 1997 and were insignificant.
Recently issued pronouncements
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AcSEC) issued Statement of Position
(SOP) 98-1 "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." SOP 98-1 provides guidance on the classification of software
project costs between expense and capital. During April 1998, AcSEC also issued
SOP 98-5 "Reporting on Costs of Start-up Activities." SOP 98-5 prescribes that
the costs of opening a new facility, commencing business in a new market, or
similar start-up activities must be expensed as incurred. Both of these
pronouncements are effective for fiscal years beginning after December 15, 1998.
SOP 98-1 is to be applied on a prospective basis to costs incurred on or after
the date of adoption. The initial application of SOP 98-5 is to be reported as a
cumulative effect of a change in accounting principle, if material. Management
intends to adopt SOP 98-1 and SOP 98-5 effective January 1, 1999.
In June 1998, the FASB issued SFAS #133 "Accounting for Derivative Instruments
and Hedging Activities." This Statement establishes accounting and reporting
standards for derivative instruments, requiring recognition of the fair value of
all derivatives as assets or liabilities on the balance sheet. SFAS #133 is
effective for fiscal years beginning after June 15, 1999. Management intends to
adopt the provisions of SFAS #133 effective January 1, 2000.
The impact of adoption of these pronouncements on the Company's financial
results is not expected to be significant.
Common stock split
On August 1, 1997, the Company's Board of Directors approved a 2-for-1 stock
split to shareholders of record at the close of business August 8, 1997,
effective August 22, 1997, and also authorized retirement of 105.3 million
common shares (pre-split) held in treasury.
18
All per share and shares outstanding data in the Consolidated Statement of
Earnings and Notes to Consolidated Financial Statements have been retroactively
restated to reflect the stock split.
Stock compensation
The Company follows Accounting Principles Board Opinion (APB) #25, "Accounting
for Stock Issued to Employees", in accounting for its employee stock options and
other stock-based compensation. Under APB #25, 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. As permitted,
the Company has elected to adopt the disclosure provisions only of SFAS #123,
"Accounting for Stock-Based Compensation." (Refer to Note 7 for further
information.)
Net 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. Weighted
average shares outstanding, in millions, were 407.8, 414.1, and 424.9 for 1998,
1997, and 1996, respectively. 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
principally comprised of employee stock options issued by the Company and had an
insignificant impact on the computation of diluted net earnings per share during
the periods presented. Weighted average shares outstanding, in millions, for
purposes of computing diluted net earnings per share were 408.6, 415.2, and
426.4 for 1998, 1997, and 1996, respectively.
Comprehensive income
Comprehensive income includes all changes in equity during a period except those
resulting from investments by or distributions to shareholders. For the Company,
comprehensive income for all periods presented consists solely of net earnings
and foreign currency translation adjustments pursuant to SFAS #52, "Foreign
Currency Translation," as follows:
19
- ----------------------------------------------------------------------------------------------------------------
(millions) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Net earnings $502.6 $546.0 $531.0
Other comprehensive income (loss):
Foreign currency translation adjustments (11.1) (112.1) 26.6
Related tax effect .6 (3.5) 1.0
- ----------------------------------------------------------------------------------------------------------------
(10.5) (115.6) 27.6
- ----------------------------------------------------------------------------------------------------------------
Total comprehensive income $492.1 $430.4 $558.6
- ----------------------------------------------------------------------------------------------------------------
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.
20
NOTE 2 ACQUISITION
On December 16, 1996, the Company purchased certain assets and liabilities of
the Lender's Bagels business from Kraft Foods, Inc. for $466 million in cash,
including related acquisition costs. The acquisition was accounted for as a
purchase. The results of Lender's operations from the date of the acquisition to
December 31, 1996, were not significant. The acquisition was initially financed
through commercial paper borrowings that were replaced with long-term debt in
January 1997. Intangible assets included in the allocation of purchase price
consisted of goodwill and trademarks of $329 million and non-compete covenants
of $20 million. The goodwill and trademarks are being amortized over 40 years
and the non-compete covenants are being amortized over 5 years.
The unaudited pro forma combined historical results, as if the Lender's Bagels
business had been acquired at the beginning of fiscal 1996, are estimated to be
net sales of $6.87 billion, net earnings of $524.3 million, and net earnings per
share of $1.23. 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 the fiscal period presented, nor are they necessarily indicative of
future consolidated results.
21
NOTE 3 NON-RECURRING CHARGES
Operating profit for 1998 includes non-recurring charges of $70.5 million ($46.3
million after tax or $.12 per share) for streamlining initiatives.
Operating profit for 1997 includes non-recurring charges of $184.1 million
($140.5 million after tax or $.34 per share), comprised of $161.1 million for
streamlining initiatives and $23.0 million for asset impairment losses.
Operating profit for 1996 includes non-recurring charges of $136.1 million
($97.8 million after tax or $.23 per share), comprised of $121.1 million for
streamlining initiatives and $15.0 million for potential settlement of certain
litigation.
Streamlining initiatives
From 1995 to the present, management has commenced major productivity and
operational streamlining initiatives in an effort to optimize the Company's cost
structure. The incremental costs of these programs have been reported throughout
1995-1998 as non-recurring charges.
The 1998 streamlining charges relate primarily to an overhead activity analysis
that result in the elimination of approximately 550 employees and 240
contractors from the Company's headquarters and North American operations
through a combination of involuntary early retirement and severance programs.
The charges consist mainly of employee retirement and separation benefits,
outplacement services, associated consulting and other related costs. Cash
outlays for the 1998 charges during 1998 were $8 million, with the remainder to
be spent during 1999. Total cash outlays during 1998 for all streamlining
initiatives were approximately $47 million.
The 1997 charges for streamlining initiatives relate principally to management's
plan to optimize the Company's pan-European operations, as well as ongoing
productivity programs in the United States and Australia. A major component of
the pan-European initiatives was the late-1997 closing of plants and separation
of employees in Riga, Latvia; Svendborg, Denmark; and Verola, Italy.
Approximately 50% of the total 1997 streamlining charges consist of
manufacturing asset write-downs, with the balance comprised of current and
anticipated cash outlays for employee separation benefits, equipment removal,
production redeployment, associated management consulting, and similar costs.
Total cash outlays during 1997 for streamlining initiatives were approximately
$85 million.
The 1996 charges for streamlining initiatives result from management's actions
to consolidate and reorganize operations in the United States, Europe, and other
international locations. Cash outlays for streamlining initiatives were
approximately $120 million in 1996. All streamlining programs commenced since
1995, including the aforementioned 1998 initiatives, are expected to result in
the elimination of approximately 3,500 employee positions by the end of 1999,
with approximately 95% of this reduction already achieved.
22
The components of the streamlining charges, as well as reserve balances
remaining at December 31, 1998, 1997, and 1996, were:
- -----------------------------------------------------------------------------------------------------------------------
Employee
retirement &
severance Asset Asset Other
(millions) benefits (a) write-offs removal costs Total
- -----------------------------------------------------------------------------------------------------------------------
Remaining reserve at
December 31, 1995 $57.5 $ - $36.5 $ - $94.0
1996 streamlining charges (b) 31.4 37.5 13.5 38.7 121.1
Amounts utilized during 1996 (65.0) (37.5) (19.6) (38.7) (160.8)
- -----------------------------------------------------------------------------------------------------------------------
Remaining reserve at
December 31, 1996 23.9 - 30.4 - 54.3
1997 streamlining charges 22.4 78.1 19.3 41.3 161.1
Amounts utilized during 1997 (22.7) (78.1) (21.4) (41.3) (163.5)
- -----------------------------------------------------------------------------------------------------------------------
Remaining reserve at
December 31, 1997 23.6 - 28.3 - 51.9
1998 streamlining charges 59.8 5.5 3.0 2.2 70.5
Amounts utilized during 1998 (43.8) (5.5) (19.4) (2.2) (70.9)
- -----------------------------------------------------------------------------------------------------------------------
Remaining reserve at
December 31, 1998 $39.6 $ - $11.9 $ - $51.5
- -----------------------------------------------------------------------------------------------------------------------
(a) Includes approximately $5 and $18 of pension and postretirement health care
curtailment losses and special termination benefits recognized in 1996 and
1998, respectively. (Refer to Notes 8 and 9.)
(b) Includes $23 of reversals of prior-year reserves due to lower than expected
employee severance payments and asset removal costs, and other favorable
factors.
Other
In addition to the non-recurring charges reported for streamlining initiatives,
the Company incurred charges for the following unusual items:
- - During 1997, asset impairment losses of $23.0 million, which resulted from
evaluation of the Company's ability to recover components of its investments
in the emerging markets of Asia-Pacific.
- - During 1996, a provision of $15.0 million for the potential settlement of
certain litigation.
1999 events
The Company's streamlining initiatives will continue throughout 1999. The
aforementioned overhead activity analysis will be extended to Europe and Latin
America during the first half of 1999. Management believes these initiatives
will result in the elimination of several hundred employee positions, requiring
separation benefit costs to be incurred. Since the number of employees affected,
their job functions, and their locations have not yet been identified, the costs
that may result are not yet known.
NOTE 4 OTHER INCOME AND EXPENSE
Other income and expense includes non-operating items such as interest income,
foreign exchange gains and losses, and charitable donations.
Other expense for 1996 includes a charge of $35.0 million ($22.3 million after
tax or $.05 per share) for a contribution to the Kellogg's Corporate Citizenship
Fund, a private trust established for charitable donations. This contribution is
expected to satisfy the charitable-giving plans of this trust through the year
2000.
NOTE 5 LEASES
Operating leases are generally for equipment and warehouse space. Rent expense
on all operating leases was $36.5 million in 1998, $38.6 million in 1997, and
$37.9 million in 1996. At December 31, 1998, future minimum annual rental
commitments under non-cancelable operating leases totaled $62 million consisting
of (in millions): 1999-$16; 2000-$12; 2001-$9; 2002-$8; 2003-$6; 2004 and
beyond-$11.
NOTE 6 DEBT
Notes payable consist of commercial paper borrowings in the United States at the
highest credit rating available, borrowings against a revolving credit agreement
in Europe and, to
23
a lesser extent, bank loans of foreign subsidiaries at competitive market rates.
U.S. borrowings at December 31, 1998, were $423.3 million with an effective
interest rate of 5.2%. U.S. borrowings at December 31, 1997 (including $400
million classified in long-term debt, as discussed in (d) below), were $744.2
million with an effective interest rate of 5.7%. Associated with these
borrowings, during September 1997, the Company purchased a $225 million
notional, four-year fixed interest rate cap. Under the terms of the cap, if the
Federal Reserve AA composite rate on 30-day commercial paper increases to 6.33%,
the Company will pay this fixed rate on $225 million of its commercial paper
borrowings. If the rate increases to 7.68% or above, the cap will expire. As of
year-end 1998, the rate was 4.90%.
In December 1998, the Company entered into a $200 million, three-year revolving
credit agreement with several international banks. At December 31, 1998,
outstanding borrowings under this agreement were $148.5 million with an
effective interest rate of 5.5%. Additionally, the Company has entered into
financing arrangements which provide for the sale of future foreign currency
revenues. As of December 31, 1998, the Company had committed to borrowings
during 1999 in the cumulative principle amount of approximately $280 million. No
borrowings were outstanding under these arrangements at December 31, 1998 or
1997. At December 31, 1998, the Company had $715.9 million of total short-term
lines of credit, of which $543.6 million were unused and available for borrowing
on an unsecured basis.
Long-term debt at year-end consisted of:
- --------------------------------------------------------------------------------
(millions) 1998 1997
- --------------------------------------------------------------------------------
(a) Seven-Year Notes due 2005 $ 200.0 $ -
(b) Seven-Year Notes due 2004 500.0 500.0
(c) Four-Year Notes due 2001 500.0 500.0
(d) Three-Year Notes due 2001 400.0 -
(e) Five-Year Notes due 1998 - 200.0
(d) Commercial paper - 400.0
Other 15.6 26.6
- --------------------------------------------------------------------------------
1,615.6 1,626.6
Less current maturities (1.1) (211.2)
- --------------------------------------------------------------------------------
Balance, December 31 $1,614.5 $1,415.4
- --------------------------------------------------------------------------------
(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. The Company entered
into a series of interest rate hedges throughout 1998 to effectively fix
the interest rate prior to issuance. The effect of the hedges, when
combined with original issue discounts, resulted in an effective interest
rate on this debt of 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%. Associated with
this debt, during September 1997, the Company entered into a $225
notional, 4 1/2 fixed-to-floating interest rate swap, indexed to the
three-month London Interbank Offered Rate (LIBOR). Under the terms of this
swap, if three-month LIBOR decreases to 4.71% or below, the swap will
expire. At year-end 1998, three-month LIBOR was 5.07%.
(C) In August 1997, the Company issued $500 of four-year 6.125% Euro Dollar
Notes. In conjunction with this issuance, the Company settled $400
notional amount of interest rate forward swap agreements which effectively
fixed the interest rate on the debt at 6.4%. Associated with this debt,
during September 1997, the Company entered into a $200 notional, four-year
fixed-to-floating interest rate swap, indexed to three-month LIBOR.
(D) At December 31, 1997, $400 of the Company's commercial paper was
classified as long-term, based on the Company's intent and ability to
refinance as evidenced by an issuance of $400 of three-year 5.75% fixed
rate U.S. Dollar Notes on February 4, 1998. These Notes were issued under
an existing "shelf registration" with the Securities and Exchange
Commission, and provide an option to holders to extend the obligation for
an additional four years at a predetermined interest rate of 5.63% plus
the
24
Company's then-current credit spread. As a result of this option, the
effective interest rate on the three-year Notes is 5.23%. Concurrent with
this issuance, the Company entered into a $400 notional, three-year
fixed-to-floating interest rate swap, indexed to the Federal Reserve AA
Composite Rate on 30-day commercial paper.
(e) In October 1993, the Company issued $200 of five-year 6.25% Euro Canadian
Dollar Notes which were swapped into 4.629% fixed rate U.S. Dollar
obligations for the duration of the five-year term.
Scheduled principal repayments on long-term debt are (in millions): 1999-$1;
2000-$6; 2001-$900; 2002-$5; 2003-$2; 2004 and beyond-$702.
Interest paid was (in millions): 1998-$113; 1997-$85; 1996-$67. Interest expense
capitalized as part of the construction cost of fixed assets was (in millions):
1998-$7.8; 1997-$9.6; 1996-$3.8.
25
NOTE 7 STOCK OPTIONS
The Key Employee Long-Term Incentive Plan provides for benefits to be awarded to
executive-level employees in the form of stock options, performance shares,
performance units, incentive stock options, restricted stock grants, and other
stock-based awards. Options granted under this plan generally vest over two
years and, prior to September 1997, vested at the date of grant. The Bonus
Replacement Stock Option Plan allows certain key executives to receive stock
options that generally vest immediately in lieu of part or all of their
respective bonus. Options granted under this plan are issued from the Key
Employee Long-Term Incentive Plan. The Kellogg Employee Stock Ownership Plan is
designed to offer stock and other incentive awards based on Company performance
to employees who are not eligible to participate in the Key Employee Long-Term
Incentive Plan. Options awarded under the Kellogg Employee Stock Ownership Plan
are subject to graded vesting over a five-year period. Under these plans (the
"stock option plans"), options are granted with exercise prices equal to the
fair market value of the Company's common stock at the time of grant,
exercisable for a 10-year period following the date of grant, subject to vesting
rules.
The Key Employee Long-Term Incentive Plan contains an accelerated ownership
feature ("AOF"). An AOF option is granted when Company stock is surrendered to
pay the exercise price of a stock option. The holder of the option is granted an
AOF option for the number of shares surrendered. For all AOF options, the
original expiration date is not changed but the options vest immediately.
As permitted by SFAS #123 "Accounting for Stock-Based Compensation," the Company
has elected to account for the stock option plans under APB #25 "Accounting for
Stock Issued to Employees." Accordingly, no compensation cost has been
recognized for these plans.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Had compensation cost
for the stock option plans been determined based on the fair value at the grant
date consistent with SFAS #123, the Company's net earnings and earnings per
share are estimated as follows:
(millions, except per share data) 1998 1997 1996
- ------------------------------------------------------------------------
Net earnings
As reported $ 502.6 $ 546.0 $ 531.0
Pro forma $ 484.4 $ 520.8 $ 514.1
Net earnings per share (basic and diluted)
As reported $ 1.23 $ 1.32 $ 1.25
Pro forma $ 1.19 $ 1.26 $ 1.21
- ------------------------------------------------------------------------
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
1998 1997 1996
- ------------------------------------------------------------------------
Risk-free interest rate 5.56% 6.31% 6.16%
Dividend yield 2.00% 1.97% 2.30%
Volatility 21.28% 19.83% 19.16%
Average expected term (years) 3.47 3.52 3.34
Fair value of options granted $8.45 $7.48 $6.32
- ------------------------------------------------------------------------
Under the Key Employee Long-Term Incentive Plan, options for 9.8 million and
13.2 million shares were available for grant at December 31, 1998 and 1997,
respectively. Under the Kellogg Employee Stock Ownership Plan, options for 6.0
million and 6.9 million shares were available for grant at December 31, 1998 and
1997, respectively. Transactions under these plans were:
(millions, except per share data) 1998 1997 1996
- ------------------------------------------------------------------------
Under option, January 1 12.4 11.2 8.4
Granted 6.8 6.0 5.2
Exercised (1.7) (4.5) (2.1)
Cancelled (1.1) (0.3) (0.3)
- ------------------------------------------------------------------------
Under option, December 31 16.4 12.4 11.2
- ------------------------------------------------------------------------
Exercisable, December 31 8.7 8.1 7.6
- ------------------------------------------------------------------------
Shares available, December 31,
for options that may be granted 15.8 20.1 23.8
- ------------------------------------------------------------------------
Average prices per share
--------------------------------
Under option, January 1 $ 35 $ 33 $ 30
Granted 43 36 38
Exercised 34 33 30
Cancelled 33 34 30
- ------------------------------------------------------------------------
Under option, December 31 $ 38 $ 35 $ 33
- ------------------------------------------------------------------------
Exercisable, December 31 $ 36 $ 36 $ 35
- ------------------------------------------------------------------------
Employee stock options outstanding and exercisable under these plans as of
December 31, 1998, were:
(millions, except Outstanding Exercisable
per share data) ------------------------------------- ----------------------
Weighted
Weighted average Weighted
Range of average remaining average
exercise Number of exercise contractual Number of exercise
prices Options price life (yrs.) Options price
- ----------------------------------------------------------------------------------
$15 - 34 5.1 $ 31 5.0 3.5 $ 30
35 - 39 3.9 38 4.9 2.6 38
40 - 44 6.6 44 1.8 1.8 43
45 - 50 0.8 48 5.7 0.8 48
- ----------------------------------------------------------------------------------
16.4 8.7
- ----------------------------------------------------------------------------------
26
NOTE 8 PENSION BENEFITS
The Company has a number of U.S. and foreign pension plans to provide retirement
benefits for its employees. 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. Plan funding strategies are
influenced by tax regulations. Plan assets consist primarily of equity
securities with smaller holdings of bonds, real estate, and other investments.
Investment in Company common stock represented 2.4% and 4.2% of consolidated
plan assets at December 31, 1998, and 1997, respectively.
The components of pension expense were:
- -----------------------------------------------------------------------------------------
(millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------
Service cost $ 41.3 $ 29.9 $ 27.6
Interest cost 81.3 79.6 72.8
Expected return on plan assets (113.9) (104.7) (95.0)
Amortization of unrecognized transition obligation 0.7 (0.3) (0.5)
Amortization of unrecognized prior service cost 7.5 7.9 7.2
Recognized losses 10.0 4.7 5.2
Curtailment loss and special
termination benefits 17.4 - 4.0
- -----------------------------------------------------------------------------------------
Pension expense - Company plans 44.3 17.1 21.3
Pension expense - multiemployer plans 1.2 1.9 2.0
- -----------------------------------------------------------------------------------------
Total pension expense $ 45.5 $ 19.0 $ 23.3
- -----------------------------------------------------------------------------------------
The worldwide weighted average actuarial assumptions were:
- -----------------------------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------------------------
Discount rate 6.7% 7.6% 7.9%
Long-term rate of compensation increase 4.9% 4.9% 5.2%
Long-term rate of return on plan assets 10.5% 10.5% 10.5%
- -----------------------------------------------------------------------------------------
The aggregate change in projected benefit obligation, change in plan assets, and
funded status were:
- ----------------------------------------------------------------------------------------------
(millions) 1998 1997
- ----------------------------------------------------------------------------------------------
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation at beginning of year $ 1,133.4 $ 1,036.3
Service cost 41.3 29.9
Interest cost 81.3 79.6
Plan participants' contributions 1.4 -
Amendments 9.6 1.3
Actuarial loss 133.6 41.1
Benefits paid (70.5) (62.7)
Other 1.1 7.9
- ----------------------------------------------------------------------------------------------
Projected benefit obligation at end of year $ 1,331.2 $ 1,133.4
- ----------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 1,209.0 $ 1,048.7
Actual return on plan assets 132.6 210.4
Employer contribution 54.7 38.8
Plan participants' contributions 1.4 -
Benefits paid (70.5) (62.7)
Other (8.9) (26.2)
- ----------------------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 1,318.3 $ 1,209.0
- ----------------------------------------------------------------------------------------------
FUNDED STATUS $ (12.9) $ 75.6
Unrecognized net loss 111.5 7.4
Unrecognized transition amount 4.2 4.4
Unrecognized prior service cost 36.2 47.2
- ----------------------------------------------------------------------------------------------
Prepaid pension $ 139.0 $ 134.6
- ----------------------------------------------------------------------------------------------
AMOUNTS RECOGNIZED IN THE STATEMENT OF FINANCIAL
POSITION CONSIST OF
Prepaid benefit cost $ 213.6 $ 185.4
Accrued benefit liability (88.4) (61.5)
Intangible asset 13.8 10.7
- ----------------------------------------------------------------------------------------------
Net amount recognized $ 139.0 $ 134.6
- ----------------------------------------------------------------------------------------------
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, in millions, $104.6, $84.5, and $8.3, respectively, as of
December 31, 1998, and $87.1, $69.1, and $15.4, respectively, as of December 31,
1997.
All gains and losses, other than curtailment losses and special termination
benefits, are recognized over the average remaining service period of active
plan participants. Curtailment losses and special termination benefits
recognized in 1998 and 1996 relate to operational workforce reduction
initiatives undertaken during these years and are recorded as a component of
non-recurring charges. (Refer to Note 3 for further information.)
Certain of the Company's subsidiaries sponsor 401(k) or similar savings plans
for active employees. Expense related to these plans was (in millions):
1998-$16; 1997-$16; 1996-$17.
NOTE 9 NONPENSION POSTRETIREMENT BENEFITS
Certain of the Company's North American subsidiaries provide health care and
other benefits to substantially all retired employees, their covered dependents,
and beneficiaries. Generally, employees are eligible for these benefits when one
of the following service/age requirements is met: 30 years and any age; 20 years
and age 55; 5 years and age 62. Plan assets consist primarily of equity
securities with smaller holdings of bonds.
27
Components of postretirement benefit expense were:
- ----------------------------------------------------------------------------------
(millions) 1998 1997 1996
- ----------------------------------------------------------------------------------
Service cost $9.1 $9.6 $11.2
Interest cost 36.8 37.2 40.2
Expected return on plan assets (15.0) (13.3) -
Amortization of unrecognized prior service cost (0.5) (0.5) 0.3
Recognized gains (5.3) (6.3) -
Curtailment loss and special
termination benefits 1.0 - 1.0
- ----------------------------------------------------------------------------------
Postretirement benefit expense $26.1 $26.7 $52.7
- ----------------------------------------------------------------------------------
The worldwide weighted average actuarial assumptions were:
- ----------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------
Discount rate 7.0% 7.25% 7.75%
Long-term rate of return on plan assets 10.5% 10.5% n/a
- ----------------------------------------------------------------------------------
The aggregate change in accumulated postretirement benefit obligation, change in
plan assets, and funded status were:
- ----------------------------------------------------------------------------------
(millions) 1998 1997
- ----------------------------------------------------------------------------------
CHANGE IN ACCUMULATED BENEFIT OBLIGATION
Accumulated benefit obligation at beginning of year $ 523.3 $ 494.1
Service cost 9.1 9.6
Interest cost 36.8 37.2
Actuarial loss 7.6 11.9
Amendments 2.2 -
Benefits paid (29.5) (29.0)
Other (0.7) (0.5)
-----------------------
Accumulated benefit obligation at end of year $ 548.8 $ 523.3
-----------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 150.7 $ 81.0
Actual return on plan assets 22.1 23.0
Employer contribution 34.1 75.7
Benefits paid (29.5) (29.0)
-----------------------
Fair value of plan assets at end of year $ 177.4 $ 150.7
-----------------------
FUNDED STATUS $ (371.4) $ (372.6)
Unrecognized net gain (80.9) (86.5)
Unrecognized prior service cost (6.2) (8.1)
-----------------------
Accrued postretirement benefit cost $ (458.5) $ (467.2)
-----------------------
AMOUNTS RECOGNIZED IN THE STATEMENT OF FINANCIAL
POSITION CONSIST OF
Accrued benefit liability $ (458.5) $ (467.2)
- ----------------------------------------------------------------------------------
The assumed health care cost trend rate was 7.0% for 1998, decreasing gradually
to 4.2% by the year 2003 and remaining at that level thereafter. These trend
rates reflect the Company's prior experience and management's expectation that
future rates will 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 $ 6.5 $ (4.2)
Effect on postretirement benefit obligation $ 65.4 $ (54.5)
- ---------------------------------------------------------------------------------------------
All gains and losses, other than curtailment losses and special termination
benefits, are recognized over the average remaining service period of active
plan participants. Curtailment losses and special termination benefits
recognized in 1998 and 1996 relate to operational workforce reduction
initiatives undertaken during these years and are recorded as a component of
non-recurring charges. (Refer to Note 3 for further information.) Since December
1996, the Company has contributed to a voluntary employee benefit association
(VEBA) trust for funding of its nonpension postretirement benefit obligations.
28
NOTE 10 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) 1998 1997 1996
- ------------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES
AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE
United States $564.0 $576.4 $516.7
Foreign 218.5 328.1 343.2
- ------------------------------------------------------------------------------------
$782.5 $904.5 $859.9
- ------------------------------------------------------------------------------------
INCOME TAXES
Currently payable
Federal $128.7 $129.4 $130.6
State 17.8 29.6 21.9
Foreign 87.2 143.0 118.4
- ------------------------------------------------------------------------------------
233.7 302.0 270.9
- ------------------------------------------------------------------------------------
Deferred
Federal 30.6 50.2 45.7
State 1.7 4.0 11.4
Foreign 13.9 (15.7) 0.9
- ------------------------------------------------------------------------------------
46.2 38.5 58.0
- ------------------------------------------------------------------------------------
Total income taxes $279.9 $340.5 $328.9
- ------------------------------------------------------------------------------------
The difference between the U.S. federal statutory tax rate and the Company's
effective rate was:
- ------------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------
U.S. statutory rate 35.0% 35.0% 35.0%
Foreign rates varying from 35% (2.0) (1.6) 0.7
State income taxes, net of federal benefit 2.4 2.4 2.5
Net change in valuation allowances 2.9 1.6 (0.1)
Statutory rate changes, deferred tax impact (0.3) (0.5) -
Other (2.2) 0.7 0.1
- ------------------------------------------------------------------------------------
Effective income tax rate 35.8% 37.6% 38.2%
- ------------------------------------------------------------------------------------
The 1998 and 1997 increases in valuation allowances on deferred tax assets and
corresponding impacts on the effective income tax rate, as presented above,
primarily 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 1998 and 1997 were $55.1 million and $30.4 million,
respectively, and principally expire after five years.
The deferred tax assets and liabilities included in the balance sheet at
year-end were:
- ------------------------------------------------------------------------------------------------------------
Deferred tax assets Deferred tax liabilities
(millions) 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------
Current:
Promotion and advertising $26.0 $65.0 $9.9 $10.5
Wages and payroll taxes 27.3 13.8 - -
Health and postretirement benefits 18.1 15.7 3.8 2.4
State taxes 5.7 8.1 - -
Operating loss and credit carryforwards 1.5 2.1 - -
Other 27.9 24.2 15.4 12.3
- ------------------------------------------------------------------------------------------------------------
106.5 128.9 29.1 25.2
Less valuation allowance (1.5) (4.1) - -
- ------------------------------------------------------------------------------------------------------------
105.0 124.8 29.1 25.2
- ------------------------------------------------------------------------------------------------------------
Noncurrent:
Depreciation and asset disposals 15.7 18.8 347.4 326.0
Health and postretirement benefits 164.3 163.5 58.8 56.2
Capitalized interest - - 28.3 28.8
State taxes - - 1.9 2.6
Operating loss and credit carryforwards 53.6 28.3 - -
Other 36.4 26.6 9.9 5.8
- ------------------------------------------------------------------------------------------------------------
270.0 237.2 446.3 419.4
Less valuation allowance (67.1) (41.8) - -
- ------------------------------------------------------------------------------------------------------------
202.9 195.4 446.3 419.4
- ------------------------------------------------------------------------------------------------------------
Total deferred taxes $307.9 $320.2 $475.4 $444.6
- ------------------------------------------------------------------------------------------------------------
At December 31, 1998, foreign subsidiary earnings of $1.2 billion were
considered permanently invested in those businesses. Accordingly, U.S. income
taxes have not been provided on these earnings. Foreign withholding taxes of
approximately $75 million would be payable upon remittance of these earnings.
Subject to certain limitations, the withholding taxes would then be available
for use as credits against the U.S. tax liability.
Cash paid for income taxes was (in millions): 1998-$211; 1997-$332; 1996-$281.
29
NOTE 11 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, notes payable, and
long-term debt approximate fair value.
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. Deferred gains or losses related to any instrument 1) designated but
ineffective as a hedge of existing assets, liabilities, or firm commitments, or
2) designated as a hedge of an anticipated transaction which is no longer likely
to occur, are recognized immediately in the statement of earnings.
For all derivative financial and commodity instruments held by the Company,
changes in fair values of these instruments and the resultant impact on the
Company's cash flows and/or earnings would generally be offset by changes in
value of underlying exposures. The impact on the Company's results and financial
position of holding derivative financial and commodity instruments was
insignificant during the periods presented.
FOREIGN EXCHANGE RISK
The Company is exposed to fluctuations in foreign currency cash flows primarily
related to third party purchases, intercompany product shipments, and
intercompany loans. 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
enters into forward contracts and other commitments to sell foreign currency
revenues, all of generally less than twelve months duration, to reduce
fluctuations in net long or short currency positions. Foreign currency contracts
are marked-to-market with net amounts due to or from counterparties recorded in
accounts receivable or payable. For contracts hedging firm commitments,
mark-to-market gains and losses are deferred and recognized as adjustments to
the basis of the transaction. For contracts hedging subsidiary investments,
mark-to-market gains and losses are recorded in the accumulated other
comprehensive income component of shareholders' equity. For all other contracts,
mark-to-market gains and losses are recognized currently in other income or
expense. Commitments to sell future foreign currency revenues are accounted for
as contingent borrowings.
The notional amounts of open forward contracts were $22.2 million and $143.2
million at December 31, 1998, and 1997, respectively. No borrowings were
outstanding under commitments to sell foreign currency revenues at December 31,
1998 or 1997. Refer to Supplemental Financial Information on pages 33 and 34 for
further information regarding these contracts.
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 uses interest rate caps, and currency and interest rate swaps, including
forward 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.
Interest rate forward swaps are marked-to-market with net amounts due to or from
counterparties recorded in interest receivable or payable. Mark-to-market gains
and losses are deferred and recognized over the life of the debt issue as a
component of interest expense. For other caps and swaps entered into
concurrently with the debt issue, the interest or currency differential to be
paid or received on the instrument is recognized in the statement of earnings as
incurred, as a component of interest expense. If a position were to be
terminated prior to maturity, the gain or loss realized upon termination would
be deferred and amortized to
30
interest expense over the remaining term of the underlying debt issue or would
be recognized immediately if the underlying debt issue was settled prior to
maturity.
The notional amounts of currency and interest rate swaps were $1.05 billion and
$875.0 million at December 31, 1998, and 1997, respectively. Refer to Note 6 and
Supplemental Financial Information on pages 33 and 34 for further information
regarding these swaps.
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 vendors, 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. Commodity
contracts are marked-to-market with net amounts due to or from brokers recorded
in accounts receivable or payable. Mark-to-market gains and losses are deferred
and recognized as adjustments to the basis of the underlying material purchase.
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 that 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. Concentrations of credit risk with respect to
accounts receivable are limited due to the large number of customers, generally
short payment terms, and their dispersion across geographic areas.
31
NOTE 12 QUARTERLY FINANCIAL DATA (unaudited)
- -----------------------------------------------------------------------------------------------------------
(millions, except Net sales Gross profit
per share data) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------
First $1,642.9 $1,688.9 $ 861.1 $ 860.9
Second 1,713.5 1,719.7 893.9 908.9
Third 1,805.8 1,803.8 936.9 944.4
Fourth 1,599.9 1,617.7 787.6 845.8
- -----------------------------------------------------------------------------------------------------------
$6,762.1 $6,830.1 $ 3,479.5 $ 3,560.0
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Earnings before Earnings per share
cumulative effect of before cumulative effect
accounting change (a) of accounting change (a)(b)
- -----------------------------------------------------------------------------------------------------------
1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------
First $170.7 $160.6 0.42 $0.38
Second 143.2 163.6 0.35 0.39
Third 141.9 207.2 0.35 0.50
Fourth 46.8 32.6 0.11 0.08
- -----------------------------------------------------------------------------------------------------------
$502.6 $564.0
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Net earnings (a) Earnings per share (a)(b)
1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------
First $170.7 $160.6 $0.42 $0.38
Second 143.2 163.6 0.35 0.39
Third 141.9 207.2 0.35 0.50
Fourth 46.8 14.6 0.11 0.04
- -----------------------------------------------------------------------------------------------------------
$502.6 $546.0
- -----------------------------------------------------------------------------------------------------------
(a) The quarterly results of 1998 and 1997 include the following non-recurring
charges and cumulative effect of accounting change. (Refer to Notes 1 and 3
for further information.)
- ----------------------------------------------------------------------------
Net earnings Earnings per share
1998 1997 1998 1997
- ----------------------------------------------------------------------------
Non-recurring charges:
Second $ - $ (8.0) $ - $ (0.02)
Third - (6.6) - (0.02)
Fourth (46.3) (125.9) (0.12) (0.31)
- ----------------------------------------------------------------------------
Earnings before cumulative
effect of accounting change (46.3) (140.5)
Cumulative effect of
accounting change - Fourth - (18.0) - (0.04)
- ----------------------------------------------------------------------------
Net earnings ($46.3) ($158.5)
- ----------------------------------------------------------------------------
(b) Earnings per share presented represent both basic and diluted earnings
per share.
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 1998, the closing price (on the
NYSE) was $34 1/8 and there were 24,634 shareholders of record.
Dividends paid and the quarterly price ranges on the NYSE during the last two
years were:
- ---------------------------------------------------------------------------------------
Stock Price
-------------------------
1998 - QUARTER Dividend High Low
- ---------------------------------------------------------------------------------------
Fourth $0.235 $37.63 $32.19
Third 0.235 39.19 29.56
Second 0.225 43.50 37.69
First 0.225 49.69 41.81
- ---------------------------------------------------------------------------------------
$0.920
- ---------------------------------------------------------------------------------------
1997 - Quarter
- ---------------------------------------------------------------------------------------
Fourth $0.225 $50.38 $40.00
Third 0.225 50.38 42.00
Second 0.210 43.44 32.00
First 0.210 36.38 32.06
- ---------------------------------------------------------------------------------------
$0.870
- ---------------------------------------------------------------------------------------
32
NOTE 13 OPERATING SEGMENTS
The Company manufactures and markets ready-to-eat cereal and other grain-based
convenience food products, including toaster pastries, frozen waffles, cereal
bars, and bagels, throughout the world. Principal markets for these products
include the United States and Great Britain. Operations are managed via four
major geographic areas - North America, Europe, Asia-Pacific, and Latin America
- - which are the basis of the Company's reportable operating segment information
disclosed below. 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) 1998 1997 1996
----------------------------------------------------------------------------------------------------------------
NET SALES
North America $ 4,175.9 $ 4,260.8 $ 4,086.3
Europe 1,698.5 1,702.0 1,749.6
Asia-Pacific 377.0 411.9 433.2
Latin America 510.7 455.4 407.5
-------------------------------------------------------
Consolidated $ 6,762.1 $ 6,830.1 $ 6,676.6
-------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
OPERATING PROFIT EXCLUDING NON-RECURRING CHARGES
North America $ 831.6 $ 884.8 $ 762.3
Europe 211.4 305.8 305.1
Asia-Pacific 48.3 51.1 61.3
Latin America 107.2 111.8 94.2
Corporate and other (232.9) (160.3) (127.9)
-------------------------------------------------------
Consolidated (a) $ 965.6 $ 1,193.2 $ 1,095.0
-------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
DEPRECIATION AND AMORTIZATION
North America $ 152.1 $ 153.7 $ 135.1
Europe 54.6 59.6 59.9
Asia-Pacific 21.3 21.9 20.7
Latin America 14.2 12.5 10.2
Corporate and other 35.9 39.6 25.6
-------------------------------------------------------
Consolidated $ 278.1 $ 287.3 $ 251.5
-------------------------------------------------------
--------------------------------------------------------------------------------------------------------------
TOTAL ASSETS
North America $ 2,430.8 $ 2,519.2 $ 2,574.0
Europe 1,336.0 1,154.5 1,254.1
Asia-Pacific 328.4 309.5 449.2
Latin America 380.9 361.4 285.6
Corporate and other 1,516.7 1,405.1 1,316.5
Elimination entries (941.3) (872.1) (829.4)
-------------------------------------------------------
Consolidated $ 5,051.5 $ 4,877.6 $ 5,050.0
-------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
ADDITIONS TO LONG-LIVED ASSETS
North America $ 82.5 $ 166.5 $ 544.6
Europe 169.1 60.7 71.9
Asia-Pacific 40.3 24.3 34.7
Latin America 41.7 43.3 17.7
Corporate and other 98.5 94.9 138.3
-------------------------------------------------------
Consolidated $ 432.1 $ 389.7 $ 807.2
-------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
(a) Reconciliation to operating profit as reported: 1998 1997 1996
Operating profit excluding
non-recurring charges $ 965.6 $ 1,193.2 $ 1,095.0
Non-recurring charges (70.5) (184.1) (136.1)
--------------------------------------------------------
Operating profit as reported $ 895.1 $ 1,009.1 $ 958.9
--------------------------------------------------------
Supplemental geographic information is provided below for revenues from external
customers and long-lived assets:
(millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
NET SALES
United States $ 3,858.0 $ 3,922.2 $ 3,733.7
Great Britain 743.6 719.0 673.8
Other foreign countries 2,160.5 2,188.9 2,269.1
----------------------------------------------------
Consolidated $ 6,762.1 $ 6,830.1 $ 6,676.6
----------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
LONG-LIVED ASSETS
United States $ 1,644.2 $ 1,707.1 $ 1,720.0
Great Britain 553.0 452.4 463.2
Other foreign countries 1,330.3 1,225.2 1,304.3
----------------------------------------------------
Consolidated $ 3,527.5 $ 3,384.7 $ 3,487.5
----------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
Supplemental product information is provided below for revenues from external
customers:
(millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
Ready-to-eat cereal net sales $ 5,265.4 $ 5,435.8 $ 5,543.8
Convenience foods net sales 1,496.7 1,394.3 1,132.8
----------------------------------------------------
Consolidated $ 6,762.1 $ 6,830.1 $ 6,676.6
----------------------------------------------------
33
NOTE 14 SUPPLEMENTAL FINANCIAL STATEMENT DATA
(millions)
- ------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF EARNINGS 1998 1997 1996
- ------------------------------------------------------------------------------------
Research and development expense $121.9 $106.1 $84.3
Advertising expense $695.3 $780.4 $778.9
====================================================================================
- ------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS 1998 1997 1996
- ------------------------------------------------------------------------------------
Accounts receivable ($102.6) $5.1 $10.9
Inventories (15.0) (8.1) (35.4)
Other current assets 33.2 (11.0) (0.5)
Accounts payable 58.9 (8.7) (41.0)
Other current liabilities (76.8) 1.9 (11.3)
- ------------------------------------------------------------------------------------
CHANGES IN OPERATING ASSETS AND LIABILITIES ($102.3) ($20.8) ($77.3)
====================================================================================
- ------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET 1998 1997
- ------------------------------------------------------------------------------------
Raw materials and supplies $133.3 $135.0
Finished goods and materials in process 318.1 299.3
- ------------------------------------------------------------------------------------
INVENTORIES $451.4 $434.3
- ------------------------------------------------------------------------------------
Deferred income taxes $89.9 $113.4
Prepaid advertising and promotion 69.9 95.2
Other 55.9 64.1
- ------------------------------------------------------------------------------------
OTHER CURRENT ASSETS $215.7 $272.7
- ------------------------------------------------------------------------------------
Land $49.3 $49.0
Buildings 1,247.9 1,213.8
Machinery and equipment 3,608.2 3,434.7
Construction in progress 341.4 283.1
Accumulated depreciation (2,358.0) (2,207.3)
- ------------------------------------------------------------------------------------
PROPERTY, NET $2,888.8 $ 2,773.3
- ------------------------------------------------------------------------------------
Goodwill $185.5 $194.3
Other intangibles 194.0 191.2
Other 286.7 251.1
- ------------------------------------------------------------------------------------
OTHER ASSETS $666.2 $636.6
- ------------------------------------------------------------------------------------
Accrued income taxes $69.4 $30.5
Accrued salaries and wages 100.7 99.7
Accrued advertising and promotion 243.4 308.8
Other 296.6 310.5
- ------------------------------------------------------------------------------------
OTHER CURRENT LIABILITIES $710.1 $749.5
- ------------------------------------------------------------------------------------
Nonpension postretirement benefits $435.2 $444.1
Deferred income taxes 259.2 237.7
Other 134.3 125.6
- ------------------------------------------------------------------------------------
OTHER LIABILITIES $828.7 $807.4
- ------------------------------------------------------------------------------------
====================================================================================
34
Report of Independent Accountants
PRICEWATERHOUSECOOPERS LLP
To the Shareholders and Board of Directors of Kellogg Company
In our opinion, the accompanying consolidated balance sheet 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 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. 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 generally accepted auditing standards 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 the opinion expressed
above.
As discussed in Note 1 to the financial statements, the Company changed its
method of accounting for business process reengineering costs effective October
1, 1997.
/s/ PriceWaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP
Battle Creek, Michigan
January 29, 1999
35
SUPPLEMENTAL FINANCIAL INFORMATION
QUANTITATIVE & QUALITATIVE DISCLOSURES RELATED TO MARKET RISK SENSITIVE
INSTRUMENTS
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. The Company, as a matter
of policy, does not engage in trading or speculative transactions. Refer to Note
11 within Notes to Consolidated Financial Statements for further information on
accounting policies related to derivative financial and commodity instruments.
FOREIGN EXCHANGE RISK
The Company is exposed to fluctuations in foreign currency cash flows related to
third party purchases, intercompany product shipments, and intercompany loans.
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. Primary exposures
include the U.S. Dollar versus the British Pound, member currencies of the
European Monetary Union, Australian Dollar, Canadian Dollar, and Mexican Peso,
and in the case of inter-subsidiary transactions, the British Pound versus other
European currencies. The Company assesses foreign currency risk based on
transactional cash flows and enters into forward contracts and other commitments
to sell foreign currency revenues, all of generally less than twelve months
duration, to reduce fluctuations in net long or short currency positions. No
borrowings were outstanding under commitments to sell foreign currency revenues
at December 31, 1998 or 1997. As of December 31, 1998, the Company had committed
to borrowings during 1999 in the cumulative principle amount of approximately
$280 million.
The tables below summarize forward contracts held at year-end 1998 and 1997. All
contracts are valued in U.S. Dollars using year-end exchange rates, are hedges
of anticipated transactions (unless indicated otherwise), and mature within one
year.
- -------------------------------------------------------------------------------------------------------------------------
CONTRACTS TO SELL FOREIGN CURRENCY
- -------------------------------------------------------------------------------------------------------------------------
CURRENCY CURRENCY NOTIONAL VALUE EXCHANGE RATE FAIR VALUE
SOLD RECEIVED (MILLIONS) (FC/1US$) (MILLIONS)
- -------------------------------------------------------------------------------------------------------------------------
1998 1997 1998 1997 1998 1997
Belgian Franc British Pound $ 1.9 $ 11.7 35.11 35.19 $ - $ 0.5
- --------------------------------------------------------------------------------------------------------------
Swiss Franc German Deutschmark 0.3 3.9 2.08 1.46 - -
- --------------------------------------------------------------------------------------------------------------
French Franc German Deutschmark - 4.3 - 6.08 - -
- --------------------------------------------------------------------------------------------------------------
French Franc Danish Kroner - 0.6 - 6.06 - -
- --------------------------------------------------------------------------------------------------------------
Danish Kroner British Pound 3.2 5.4 6.60 6.67 (0.1) 0.1
- --------------------------------------------------------------------------------------------------------------
Belgian Franc French Franc - 1.0 - 36.87 - -
- --------------------------------------------------------------------------------------------------------------
French Franc British Pound 6.9 48.0 5.69 5.70 (0.1) 2.3
- --------------------------------------------------------------------------------------------------------------
Irish Punt British Pound 3.4 27.4 0.68 0.66 - 1.7
- --------------------------------------------------------------------------------------------------------------
Spanish Peseta British Pound - 1.3 - 134.72 - 0.2
- --------------------------------------------------------------------------------------------------------------
Swedish Kroner Danish Kroner 1.6 16.0 7.41 7.89 0.1 0.1
- --------------------------------------------------------------------------------------------------------------
Venezuelan Bolivar U.S. Dollar 2.1 - 726.67 - (0.6) -
- --------------------------------------------------------------------------------------------------------------
TOTAL $ 19.4 $ 119.6 $ (0.7) $ 4.9
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
CONTRACTS TO PURCHASE FOREIGN CURRENCY
- -------------------------------------------------------------------------------------------------------------------------
CURRENCY CURRENCY NOTIONAL VALUE EXCHANGE RATE FAIR VALUE
PURCHASED EXCHANGED (MILLIONS) (FC/1US$) (MILLIONS)
- -------------------------------------------------------------------------------------------------------------------------
1998 1997 1998 1997 1998 1997
Swiss Franc (a) British Pound $ - $ 4.7 - 1.42 $ - $ (0.1)
- --------------------------------------------------------------------------------------------------------------
German Deutschmark (a) British Pound - 0.3 - 1.72 - -
- --------------------------------------------------------------------------------------------------------------
German Deutschmark British Pound 2.8 18.6 1.69 1.71 - (0.8)
- --------------------------------------------------------------------------------------------------------------
TOTAL $ 2.8 $ 23.6 $ - $ (0.9)
- -------------------------------------------------------------------------------------------------------------------------
(a) Designated as hedge of firm commitment.
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.
Primary exposures include movements in U.S. Treasury rates, London Interbank
Offered rates (LIBOR), and commercial paper rates. The Company uses interest
rate caps, and currency and interest rate swaps, including forward 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.
The tables below provide information on the Company's significant debt issues
and related hedging instruments at year-end 1998 and 1997. For foreign
currency-denominated debt, the information is presented in U.S. Dollar
equivalents. Variable interest rates are based
- --------------------------------------------------------------------------------------------------------------
SIGNIFICANT DEBT ISSUES 12/31/98 12/31/97
- --------------------------------------------------------------------------------------------------------------
DEBT PRINCIPAL BY YEAR OF MATURITY (MILLIONS) FAIR VALUE FAIR VALUE
--------------------------------------- (MILLIONS) (MILLIONS)
CHARACTERISTICS 1999 2001 2004 2005
- --------------------------------------------------------------------------------------------------------------
Euro Dollar $ 500.0 $ 505.8 $ 502.6
- --------------------------------------------------------------------------------------------------------------
fixed rate 6.125%
- --------------------------------------------------------------------------------------------------------------
effective rate (a) 6.400%
- --------------------------------------------------------------------------------------------------------------
U.S. Dollar $ 400.0 $ 435.9 $ -
- --------------------------------------------------------------------------------------------------------------
fixed rate 5.75%
- --------------------------------------------------------------------------------------------------------------
effective rate (b) 5.23%
- --------------------------------------------------------------------------------------------------------------
Euro Dollar $ 500.0 $ 510.2 $ 515.3
- --------------------------------------------------------------------------------------------------------------
fixed rate 6.625%
- --------------------------------------------------------------------------------------------------------------
effective rate (a) 6.354%
- --------------------------------------------------------------------------------------------------------------
U.S. Dollar $ 200.0 $ 198.4 $ -
- --------------------------------------------------------------------------------------------------------------
fixed rate 4.875%
- --------------------------------------------------------------------------------------------------------------
effective rate (a) 6.070%
- --------------------------------------------------------------------------------------------------------------
U.S. commercial paper $ 423.3 $ 423.3 $ -
- --------------------------------------------------------------------------------------------------------------
weighted avg. variable 5.2%
- --------------------------------------------------------------------------------------------------------------
Multi-currency revolving credit facility $ 148.5 $ 148.5 $ -
- --------------------------------------------------------------------------------------------------------------
effective rate 5.5%
- --------------------------------------------------------------------------------------------------------------
Other debt issues maturing in 1998:
- --------------------------------------------------------------------------------------------------------------
Euro Canadian Dollar $ - $ 186.6
- --------------------------------------------------------------------------------------------------------------
U.S. commercial paper (c) $ - $ 744.2
- --------------------------------------------------------------------------------------------------------------
(a) Effective fixed interest rate paid, as a result of settlement of forward
interest rate swap at date of debt issuance.
(b) Effective fixed interest rate paid, as a result of extendable feature. Refer
to Note 6 within Notes to Consolidated Financial Statements for further
information.
(c) $400 million of commercial paper classified in long-term debt as of year-end
1997. Refer to Note 6 within Notes to Consolidated Financial Statements for
further information.
36
on effective rates or implied forward rates as of year-end 1998. Refer to Note 6
within the Notes to Consolidated Financial Statements for further information.
- ---------------------------------------------------------------------------------------------------
INTEREST & CURRENCY SWAPS & CAPS
- ---------------------------------------------------------------------------------------------------
12/31/98 12/31/97
INSTRUMENT YEAR OF MATURITY (MILLIONS) FAIR VALUE FAIR VALUE
---------------------------
CHARACTERISTICS 2001 2002 (MILLIONS) (MILLIONS)
- ---------------------------------------------------------------------------------------------------
Interest rate swap -- pay Notional amt. $ 200.0 $ 5.6 $ 1.3
-----------------------------------------------------------------
variable/receive fixed -- hedge Pay 5.22%
-----------------------------------------------------------------
of existing debt issue Receive 6.40%
-----------------------------------------------------------------
Interest rate swap -- pay Notional amt. $ 225.0 $ 1.1 $ 1.2
-----------------------------------------------------------------
variable/receive fixed -- hedge Pay 4.86%
-----------------------------------------------------------------
of existing debt issue (a) Receive 6.354%
-----------------------------------------------------------------
Interest rate swap -- pay Notional amt. $ 400.0 $ 5.2 $ -
-----------------------------------------------------------------
variable/receive fixed -- hedge Pay 4.49%
-----------------------------------------------------------------
of existing debt issue Receive 5.23%
-----------------------------------------------------------------
Interest rate cap -- pay fixed
if 30-day C.P. rate rises to Notional amt. $ 225.0 $ (0.2) $ (0.4)
strike rate hedge of U.S. -----------------------------------------------------------------
commercial paper (b) Strike 6.33%
-----------------------------------------------------------------
Reference 4.90%
-----------------------------------------------------------------
Other swaps settling in 1998 $ - $ (10.9)
- ---------------------------------------------------------------------------------------------------
(a) Under the terms of this swap, if three-month LIBOR falls to 4.71% or below,
the swap will expire. At year-end 1998, three-month LIBOR was 5.07%.
(b) Under the terms of this cap, if the Federal Reserve AA composite rate on
30-day commercial paper increases to 7.68% or above, the cap will expire.
At year-end 1998 the rate was 4.90%.
PRICE RISK
The 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, and sugar. The Company uses the combination of long
cash positions with vendors, 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 fair values of commodity contracts
held at year-end 1998 and 1997 were insignificant, and potential near-term
changes in commodity prices are not expected to have a significant impact on the
Company's future earnings or cash flows.
For all derivative financial instruments presented in the tables above, changes
in fair values of these instruments and the resultant impact on the Company's
cash flows and/or earnings would generally be offset by changes in values of
underlying transactions and positions. Therefore, it should be noted that the
exclusion of certain of the underlying exposures from the tables above may be a
limitation in assessing the net market risk of the Company.