EX-13.01 9 k74347exv13w01.txt ANNUAL REPORT TO SHARE OWNERS FOR FISCAL YEAR END EXHIBIT 13.01 MANAGEMENT'S DISCUSSION AND ANALYSIS KELLOGG COMPANY AND SUBSIDIARIES RESULTS OF OPERATIONS OVERVIEW Kellogg Company is the world's leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles, meat alternatives, pie crusts, and ice cream cones. Kellogg products are manufactured and marketed globally. Our Company is managed in two major divisions - the United States and International - with International further delineated into Europe, Latin America, Canada, Australia, and Asia. This organizational structure is the basis of the operating segment data presented in this report. Over the past three years, we have transformed our Company to align with key operating principles first adopted in late 2000. These principles emphasize a stricter prioritization for resource allocation to the United States and our other core markets, a stronger emphasis on cash flow, and a focus on net sales value over shipment volume. This focus drives gross margin expansion to fund marketing investment. We believe the progression of our financial performance over this three-year period reflects both the significant transition we have undertaken and, more importantly, the ultimate success of our growth strategy. During 2000, to facilitate resource prioritization, we reorganized our company from four operating areas into two divisions - U.S. and International. As a result, we initiated restructuring actions around the world to support our strategy and new organization, including staff reductions in our global organization, rationalization of international convenience foods capacity, and restructuring of various non-core markets to improve return on investment. In addition to the disruption of this significant restructuring, we faced many financial challenges in 2000 such as softness in our U.S. convenience foods business, higher energy prices and interest rates, weak foreign currencies, and inventory write-offs in Southeast Asia. Despite these challenges, we were able to deliver net earnings growth through manufacturing efficiencies, reduced advertising and overhead expenses, and recognition of benefits related to U.S. tax credits. During 2001, our Company experienced a significant transition related to the acquisition and integration of Keebler Foods Company (the "Keebler acquisition"), as well as the fundamental refocus of our business model. While net earnings were dampened by increased interest and tax expense, and other short-term financial impacts of this transition, we achieved three important goals during 2001: increased dollar share in the U.S. cereal category; pricing and mix-related improvements in gross profit margin; and the highest cash flow (net cash provided from operating activities less expenditures for property additions) to date in our Company's history. Building on the groundwork laid in 2000 and 2001, our Company in 2002 established a trend of solid performance in several key metrics: internal sales growth, expansion of gross profit margin, and continued strong cash flow. We believe improved execution, increased brand-building investment, and a focus on value over volume were important drivers of this performance. The following items affect the comparability of current and prior-year results: _ On January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets." Under the provisions of this standard, substantially all of our amortization expense was eliminated in periods subsequent to adoption. Management's measure of operating segment profitability has been restated for all prior years to conform to the current-year presentation. _ Sales and operating profit for 2001 were reduced by the financial impact of Keebler integration activities. _ Operating profit for 2001 and 2000 included restructuring charges related to implementing our operating principles and preparing Kellogg for the Keebler integration. _ During 2001, net earnings included an extraordinary loss related to extinguishment of long-term debt and a charge for the cumulative effect of an accounting change. Reported results are reconciled to adjusted results, as follows:
==================================================================================== Net earnings (millions) Change vs. prior year ------------------------------------------------------------------------------------ 2002 2001 2000 2002 2001 ------------------------------------------------------------------------------------ Reported consolidated results $720.9 $473.6 $587.7 52.2% -19.4% Restructuring charges, net of credits -- 20.5 64.2 Integration impact -- 46.2 -- Amortization eliminated by SFAS No. 142 -- 85.0 9.6 Extraordinary loss -- 7.4 -- Cumulative effect of accounting change -- 1.0 -- ------------------------------------------------------------------------------------ Adjusted consolidated results $720.9 $633.7 $661.5 13.8% -4.2% ==================================================================================== ==================================================================================== Net earnings per share Change vs. prior year ------------------------------------------------------------------------------------ 2002 2001 2000 2002 2001 ------------------------------------------------------------------------------------ Reported basic net earnings per share $1.77 $1.17 $1.45 51.3% -19.3% Dilution impact (.02) (.01) -- ------------------------------------------------------------------------------------ Reported diluted net earnings per share $1.75 $1.16 $1.45 Restructuring charges, net of credits -- .05 .16 Integration impact -- .11 -- Amortization eliminated by SFAS No. 142 -- .21 .02 Extraordinary loss -- .02 -- Cumulative effect of accounting change -- -- -- ------------------------------------------------------------------------------------ Adjusted consolidated results $1.75 $1.55 $1.63 12.9% -4.9% ====================================================================================
For 2002, the increase in adjusted net earnings per share of $.20 was comprised of $.16 of business growth, $.09 from a reduced effective income tax rate, $.02 from favorable legal settlements during the first Kellogg Company 21 quarter, and $.01 from favorable foreign currency movements, partially offset by $.06 from increased interest expense and $.02 related to an increase in diluted shares outstanding versus the prior year. For 2001, the decrease in adjusted earnings per share of $.08 was primarily the result of $.34 from incremental interest expense, $.17 from a higher effective tax rate, and $.07 from unfavorable foreign currency movements. This was offset by $.50 from business growth, including the results of the Keebler business. NET SALES AND OPERATING PROFIT 2002 COMPARED TO 2001 The following tables provide an analysis of net sales and operating profit performance for 2002 versus 2001:
================================================================================================== Other United Latin operating Consoli- (dollars in millions) States Europe America (g) Corporate dated -------------------------------------------------------------------------------------------------- 2002 NET SALES $5,525.4 $1,469.8 $631.1 $677.8 $-- $8,304.1 2001 NET SALES (a) $4,889.4 $1,360.7 $650.0 $648.3 $-- $7,548.4 -------------------------------------------------------------------------------------------------- % change - 2002 vs. 2001: Volume .3% -- .1% -3.2% -- -.2% Pricing/mix 3.8% 2.4% 6.6% 5.6% -- 4.2% -------------------------------------------------------------------------------------------------- SUBTOTAL - INTERNAL BUSINESS 4.1% 2.4% 6.7% 2.4% -- 4.0% Integration impact (b) .4% -- -- -- -- .2% Acquisitions & dispositions (c) 8.5% -- -- -- -- 5.5% Foreign currency impact -- 5.6% -9.6% 2.2% -- .3% -------------------------------------------------------------------------------------------------- TOTAL CHANGE 13.0% 8.0% -2.9% 4.6% -- 10.0% ================================================================================================== ================================================================================================== Other United Latin operatinG Consoli- (dollars in millions) States Europe America (g) Corporated dated -------------------------------------------------------------------------------------------------- 2002 SEGMENT OPERATING PROFIT $1,073.0 $252.5 $170.1 $104.0 $(91.5) $1,508.1 -------------------------------------------------------------------------------------------------- 2001 operating profit (d) $745.5 $245.8 $170.7 $101.6 $(95.7) $1,167.9 Restructuring charges (e) 29.5 (.2) (.1) 1.4 2.7 33.3 Amortization (f) 100.5 -- .5 .1 2.5 103.6 -------------------------------------------------------------------------------------------------- 2001 SEGMENT OPERATING PROFIT $ 875.5 $245.6 $171.1 $103.1 $(90.5) $1,304.8 -------------------------------------------------------------------------------------------------- % change-- 2002 vs. 2001: INTERNAL BUSINESS 10.6% -3.1% 4.9% -1.4% -10.5% 6.4% Integration impact (b) 8.7% -- -- -- 9.4% 6.3% Acquisitions & dispositions (c) 3.3% -- -- -- -- 2.3% Foreign currency impact -- 5.9% -5.5% 2.2% -.1% .6% -------------------------------------------------------------------------------------------------- TOTAL CHANGE 22.6% 2.8% -.6% .8% -1.2% 15.6% ==================================================================================================
(a) 2001 net sales restated for the retroactive application of EITF No. 01-09. Refer to Note 1 within Notes to Consolidated Financial Statements for further information. (b) Impact of Keebler integration activities during 2001. Refer to discussion of results of operations in paragraphs following these tables for further information. (c) Impact of results for the first twelve weeks of 2002 from Keebler Foods Company, acquired in March 2001; and impact of results for the comparable 2001 period subsequent to the April 29, 2002, divestiture of the Bake-Line private label business. (d) 2001 U.S. operating segment profitability restated for an internal reallocation of overhead between corporate and U.S. operations. (e) Refer to "Restructuring and other charges" section beginning on page 24 for further information. (f) Pro forma impact of amortization eliminated by SFAS No. 142. Refer to Note 1 within Notes to Consolidated Financial Statements for further information. (g) Includes Canada, Australia, and Asia. During 2002, we achieved strong internal sales growth of 4% on a consolidated basis, resulting primarily from pricing and mix improvements in all operating segments. U.S. net sales in the retail cereal business increased approximately 6% and total international sales increased over 3% in local currencies. Adjusting the prior period to a comparable basis for the impact of acquisitions, divestitures, and Keebler integration activities, U.S. net sales in the retail snacks business increased nearly 1%, as a double-digit increase in sales of our wholesome snack products offset a decline in cookie and cracker sales. We believe this decline was primarily a result of weak consumption in the cookie and cracker categories throughout the year and our decision to cancel an end-of-year sales force incentive in order to improve efficiencies in our direct store door (DSD) delivery system. During 2002, consolidated and U.S. internal operating profit increased approximately 6% and 11%, respectively. Total international local currency operating profit was approximately even with the prior year, held down by a double-digit increase in marketing investment to drive core market sales growth. During 2001, sales and operating profit were reduced by the financial impact of Keebler integration activities ("integration impact"). This integration impact consisted primarily of 1) the sales and gross profit effect of lowering trade inventories to transfer our snack foods to Keebler's DSD system during the second quarter, 2) direct costs for employee incentive and retention programs, employee separation and relocation benefits, and consulting contracts, and 3) impairment and accelerated depreciation of software assets being abandoned due to the conversion of our U.S. business to the SAP system. We estimate that these activities reduced net sales by $17.8 million, increased cost of goods sold by $5.6 million, and increased selling, general, and administrative expense by $51.0 million, for a total 2001 operating profit reduction of $74.4 million. 2001 COMPARED TO 2000 The following tables provide an analysis of net sales and operating profit performance for 2001 versus 2000:
================================================================================================ Other United Latin operating Consoli- (dollars in millions) States Europe America (g) Corporate dated ------------------------------------------------------------------------------------------------ 2001 NET SALES (a) $4,889.4 $1,360.7 $650.0 $648.3 $ -- $7,548.4 2000 NET SALES (a) $3,263.6 $1,462.2 $624.3 $716.1 $20.5 $6,086.7 % change - 2001 vs. 2000: Volume .8% -6.8% 1.8% -1.7% -- -1.4% Pricing/mix 1.9% 4.6% 3.0% -.7% -- 2.3% ------------------------------------------------------------------------------------------------ SUBTOTAL - INTERNAL BUSINESS 2.7% -2.2% 4.8% -2.4% -- .9% Integration impact (b) -.6% -- -- -- -- -.3% Acquisitions (c) 47.7% -- -- .6% -- 25.6% Foreign currency impact -- -4.7% -.7% -7.7% -- -2.2% ------------------------------------------------------------------------------------------------ TOTAL CHANGE 49.8% -6.9% 4.1% -9.5% -- 24.0% ================================================================================================
22 Kellogg Company
================================================================================================ Other United Latin operating Consoli- (dollars in millions) States Europe America (g) Corporate dated ------------------------------------------------------------------------------------------------ 2001 operating profit (d) $745.5 $245.8 $170.7 $101.6 $(95.7) $1,167.9 Restructuring charges (e) 29.5 (.2) (.1) 1.4 2.7 33.3 Amortization (f) 100.5 -- .5 .1 2.5 103.6 ------------------------------------------------------------------------------------------------ 2001 SEGMENT OPERATING PROFIT $875.5 $245.6 $171.1 $103.1 $(90.5) $1,304.8 ------------------------------------------------------------------------------------------------ 2000 operating profit (d) $659.2 $208.5 $146.5 $60.5 $(84.9) $989.8 Restructuring charges (e) 2.0 26.7 14.6 28.7 14.5 86.5 Amortization (f) 9.1 -- .6 -- 2.5 12.2 ------------------------------------------------------------------------------------------------ 2000 SEGMENT OPERATING PROFIT $670.3 $235.2 $161.7 $89.2 $(67.9) $1,088.5 ------------------------------------------------------------------------------------------------ % change - 2001 vs. 2000: INTERNAL BUSINESS -4.9% 9.9% 5.2% 24.6% -8.7% 2.5% Integration impact (b) -9.9% -- -- -- -11.4% -6.8% Acquisitions (c) 45.4% -- -- .6% -- 28.0% Foreign currency impact -- -5.5% .6% -9.6% -13.2% -3.8% ------------------------------------------------------------------------------------------------ TOTAL CHANGE 30.6% 4.4% 5.8% 15.6% -33.3% 19.9% ================================================================================================
(a) 2001 and 2000 net sales restated for the retroactive application of EITF No. 01-09. Refer to Note 1 within Notes to Consolidated Financial Statements for further information. (b) Impact of Keebler integration activities during 2001. Refer to page 22 for further information. (c) Impact of results for applicable portion of 2001 from Keebler Foods Company, acquired in March 2001; Kashi Company, acquired in June 2000, and The Healthy Snack People business, an Australian convenience foods operation, acquired in July 2000. (d) 2001 and 2000 U.S. operating segment profitability restated for an internal reallocation of overhead between corporate and U.S. operations. (e) Refer to "Restructuring and other charges" section beginning on page 24 for further information. (f) Proforma impact of amortization eliminated by SFAS No. 142. Refer to Note 1 within Notes to Consolidated Financial Statements for further information. (g) Includes Canada, Australia, and Asia. On an internal business basis, consolidated net sales for 2001 increased nearly 1%, as a 2% increase in U.S. cereal sales to the retail channel was offset by declines in U.S. snack sales and in all international segments except Latin America and Canada. The decline in U.S. snack sales was due primarily to our product rationalization initiative and postponed innovation and marketing support during the integration of this business into the Keebler DSD system. The decline in international sales was driven by the discontinuation of our private-label program in Germany and continued cereal category softness in the United Kingdom and Australia. On an internal business basis, consolidated operating profit for 2001 grew over 2%. Increased profitability in international businesses offset the impact of the internal sales declines discussed above, as well as the impact of increased marketing investment in the U.S. cereal business and additional sales force hiring and training costs in the United States. In Southeast Asia, operating profit for 2000 was reduced by approximately $14 million in aged inventory write-offs and related expenses as management initiated restructuring actions to refocus certain markets on sustainable growth. The inclusion of the Keebler business in consolidated results increased our net sales by approximately 25% and segment operating profit by approximately 27% versus the prior year. Assuming we had owned Keebler during the comparable prior-year period, 2001 consolidated net sales (excluding foreign currency and integration impacts) would have been approximately even with the prior year. Similarly, operating profit (excluding Keebler amortization expense, restructuring charges, foreign currency, and integration impacts) would have increased approximately 4%. Keebler's net sales for full-year 2001 (excluding Kellogg snacks integrated into the DSD system) decreased approximately 1% versus the prior year, primarily as a result of our product rationalization initiative, exit of various non-strategic custom manufacturing contracts, and postponement of new product introductions during the integration process. MARGIN PERFORMANCE Margin performance is presented in the following table. All results for 2001 and 2000 exclude the impact of restructuring charges and amortization expense that would have been eliminated if SFAS No. 142 had been applied in the prior year. Results for 2001 and 2000 also have been restated for the retroactive application of EITF Issue No. 01-09 (refer to Note 1 within Notes to Consolidated Financial Statements) related to the reclassification of certain promotional expenditures from selling, general, and administrative expense (SGA) to net sales and cost of goods sold.
================================================================================================ SFAS No. 142 adjusted (b) Change vs. prior year (pts.) ------------------------------------------------------------------------------------------------ 2002 2001 2000 2002 2001 ------------------------------------------------------------------------------------------------ Gross margin 45.0% 44.3% 44.2% .7 .1 SGA% (a) -26.8% -27.0% -26.3% .2 -.7 ------------------------------------------------------------------------------------------------ Operating margin 18.2% 17.3% 17.9% .9 -.6 ================================================================================================
(a) Selling, general, and administrative expense as a percentage of net sales. (b) Results adjusted for the impact of amortization eliminated by SFAS No. 142. Refer to Note 1 within Notes to Consolidated Financial Statements for further information. The 2002 gross margin improvement was attributable primarily to higher average pricing, improved mix, operating leverage, and cost savings related to the Keebler acquisition. Excluding the impact of premium inserts and other package-related promotional costs recorded in cost of goods sold, our 2002 gross margin would have been 110 basis points higher or 46.1% and our 2001 gross margin would have been 80 basis points higher or 45.1%. Our 2002 gross margin also was favorably impacted by recognition of a $16.9 million curtailment gain related to a change in certain retiree health care plans, largely offset by asset impairment losses, and costs and asset write-offs associated with various ongoing supply chain efficiency initiatives. For 2001, the gross margin improvement was attributable to sales of higher-margin Keebler products, cereal price increases in the United States and Europe, and efforts to improve our global sales mix. The gross margin improvement was offset by an increase in SGA%, resulting in an operating margin comparable to the prior year. The higher SGA% was attributable principally to expenditures for marketing programs, U.S. sales force expansion, and improved employee performance incentives. Kellogg Company 23 INTEREST EXPENSE For 2002, gross interest expense, prior to amounts capitalized, increased 11% versus the prior year, due to the extra quarterly period of interest on Keebler acquisition-related debt. The year-over-year increase was minimized due to continuous pay-down of debt balances throughout the year and lower short-term market rates of interest. For 2001, gross interest expense increased significantly versus the prior year, due primarily to interest expense on debt issued late in the first quarter to finance the Keebler acquisition. (Refer to the "Liquidity and capital resources" section beginning on page 25 for further information.)
================================================================================================ (dollars in millions) Change vs. prior year ------------------------------------------------------------------------------------------------ 2002 2001 2000 2002 2001 ------------------------------------------------------------------------------------------------ Reported interest expense $391.2 $351.5 $137.5 Amounts capitalized 1.0 2.9 5.6 ------------------------------------------------------------------------------------------------ Gross interest expense $392.2 $354.4 $143.1 10.7% 147.7% ================================================================================================
We currently expect reported total year 2003 interest expense to be reduced to approximately $360 million, as we continue to pay down our debt balances. OTHER INCOME (EXPENSE), NET Other income (expense), net includes non-operating items such as interest income, foreign exchange gains and losses, charitable donations, and gains on asset sales. Other income (expense), net for 2002 consists primarily of a $24.7 million credit related to legal settlements, of which $16.5 million was received in the first quarter with the remainder received throughout subsequent quarters. Other income (expense), net for 2000 includes a credit of approximately $12 million related to the 1999 sale of the Lender's Bagels business. INCOME TAXES The effective income tax rate for 2001 of 40% reflected the impact of the Keebler acquisition on nondeductible goodwill and the level of U.S. tax on foreign subsidiary earnings. As a result of our adoption of SFAS No. 142 on January 1, 2002 (refer to Note 1 within Notes to Consolidated Financial Statements), goodwill amortization expense -and the resulting impact on the effective income tax rate - has been eliminated in periods subsequent to adoption. Accordingly, the 2002 effective income tax rate was reduced to 37%, which is consistent with pre-2000 historical levels. The 2000 effective income tax rate was unusually low, due to the recognition of $33 million in U.S. research and foreign tax credits.
================================================================================================ Effective income tax rate Change vs. prior year (pts.) ------------------------------------------------------------------------------------------------ 2002 2001 2000 2002 2001 ------------------------------------------------------------------------------------------------ Adjusted (a) 37.0% 40.0% 31.7% -3.0 8.3 ------------------------------------------------------------------------------------------------ As reported 37.0% 40.1% 32.3% -3.1 7.8 ================================================================================================
(a) Results for 2001 and 2000 exclude the impact of restructuring charges. Results for 2001 also exclude the impact of extraordinary loss from debt extinguishment and accounting change. As a result of implementing various foreign and state tax planning initiatives, we currently expect our 2003 consolidated effective tax rate to be reduced to approximately 36%. RESTRUCTURING AND OTHER CHARGES Cost of goods sold for 2002 includes a charge of $5.7 million related to our planned divestiture of certain private-label operations in Australia. The charge is comprised principally of an impairment loss to reduce the carrying value of production assets held for sale to estimated fair value less cost to sell. During December 2002, we sold these assets for an amount in excess of the previously estimated fair value, and recorded a credit to cost of goods sold of $2.3 million. Cost of goods sold for 2002 includes an impairment loss of $5.0 million related to our manufacturing facility in China, representing a decline in real estate market value subsequent to an original impairment loss recognized for this property in 1997. We are now in the process of selling this facility and currently believe the carrying value reflects fair value less cost to sell. Net earnings for 2001 include an extraordinary loss of $7.4 million, net of tax benefit of $4.2 million $(.02 per share), related to the extinguishment of $400 million of long-term debt. In April 2002, the FASB issued SFAS No. 145, a technical corrections pronouncement which, in part, rescinds SFAS No. 4 "Reporting Gains and Losses from Extinguishment of Debt." Under SFAS No. 145, generally, debt extinguishments will no longer be classified as extraordinary items. As a result of adopting this standard for our 2003 fiscal year, the extraordinary loss for 2001 will be reclassified to conform to the presentation for 2003 and subsequent years. On January 1, 2001, we adopted SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." During 2001, we recorded a charge to earnings of $1.0 million, net of tax benefit of $.6 million, and a charge to other comprehensive income of $14.9 million, net of tax benefit of $8.6 million, in order to recognize the fair value of derivative instruments as either assets or liabilities on the balance sheet. As discussed in the "Overview" section on page 21, during 2000 and 2001 we undertook significant restructuring actions to align resources with our growth strategy. The incremental costs of these actions were reported as restructuring charges during these years. Operating profit for 2001 includes net restructuring charges of $33.3 million $(20.5 million after tax or $.05 per share), comprised of charges of $48.3 million and credits of $15.0 million. The charges are related to preparing Kellogg for the Keebler integration and continued actions supporting our growth strategy in the United States and Southeast Asia. Approximately 70% of these charges were comprised of asset write-offs, with the remainder consisting of employee severance and other cash costs. The credits result from adjustments to various restructuring and asset disposal reserves associated with the completion of numerous multi-year initiatives. Operating profit for 2000 includes restructuring charges of $86.5 million $(64.2 million after tax or $.16 per share), consisting of $65.2 million for actions in various locations supporting our growth strategy and $21.3 million for a supply chain efficiency initiative in Europe. 24 Kellogg Company Approximately one-half of the charges were comprised of asset write-offs with the remainder consisting principally of cash costs for involuntary employee separation benefits. Total cash outlays incurred for restructuring programs were approximately $8 million in 2002, $35 million in 2001, and $68 million in 2000. At the end of 2002, all restructuring programs were complete and remaining reserves of $1.4 million consisted solely of long-term contractual obligations for severance. Refer to Note 3 within Notes to Consolidated Financial Statements for further information. In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal," which is effective for exit or disposal activities initiated after December 31, 2002, with early application encouraged. We have adopted SFAS No. 146 for our 2003 fiscal year. This statement is intended to achieve consistency in timing of recognition between exit costs, such as one-time employee separation benefits and contract termination payments, and all other costs. Under pre-existing literature, certain costs associated with exit activities were recognized when management committed to a plan. Under SFAS No. 146, costs are recognized when a liability has been incurred under general concepts. For instance, under pre-existing literature, plant closure costs would be accrued at the plan commitment date. Under SFAS No. 146, these costs would be recognized as closure activities are performed. These provisions could be expected to have the general effect of delaying recognition of certain costs related to restructuring programs. However, we do not currently expect adoption of this standard to have a significant impact on our 2003 financial results. KEEBLER ACQUISITION On March 26, 2001, we acquired Keebler Foods Company in a cash transaction valued at $4.56 billion. The acquisition was accounted for under the purchase method and was financed through a combination of short-term and long-term debt. The final purchase price allocation includes $71.3 million of liabilities related to our plans, as of the acquisition date, to exit certain activities and operations of the acquired company. Cash outlays related to these exit plans were approximately $28 million in 2001 and approximately $24 million in 2002, with the remaining amounts to be spent principally during 2003. Our exit plans are being announced as individual initiatives are implemented. In August 2002, we announced plans to consolidate certain functions in Battle Creek, Michigan, primarily research, technology, and financial services. As a result, approximately 70 positions in Elmhurst, Illinois, were relocated or eliminated. During November 2002, we commenced the process of consolidating ice cream cone and pie crust manufacturing operations from several facilities to a single facility in Chicago, Illinois. Other major initiatives begun in 2002 included the reconfiguration of Keebler's DSD system in the southeastern United States to accommodate Kellogg snack product volume, which has resulted in early termination of leases on approximately 100 small vans and separation of approximately 85 sales representatives and support personnel. Exit plans implemented during 2001 included separation of approximately 90 Keebler administrative employees and the closing of a bakery in Denver, Colorado, eliminating approximately 440 employee positions. During June 2001, we communicated plans to transfer portions of Keebler's Grand Rapids, Michigan, bakery production to other plants in the United States during the next 12 months. As a result, approximately 150 employee positions were eliminated, partly through a voluntary retirement program. During April 2002, we sold certain assets of Keebler's Bake-Line private-label unit, including a bakery in Marietta, Oklahoma, to Atlantic Baking Group, Inc. for approximately $65 million in cash and a $10 million note to be paid at a later date. In January 2003, we sold additional private-label operations for approximately $14 million in cash. For both of these transactions, the carrying value of net assets sold, including allocated goodwill, approximated the net sales proceeds. LIQUIDITY AND CAPITAL RESOURCES For 2002, net cash provided by operating activities was $999.9 million, compared to $1.13 billion in the prior-year period. Operating cash flow for 2002 declined slightly versus the prior year, due to a significant year-over-year increase in employee benefit plan contributions. Excluding the after-tax impact of December 2002 voluntary contributions of approximately $254 million, our 2002 operating cash flow would have exceeded the 2001 level by approximately $121 million, buoyed by operating profit growth and strong "core working capital" (trade receivables and inventory, less trade payables) management. Core working capital as a percentage of sales continued to improve versus the prior year. For 2002, average core working capital represented 8.8% of net sales, versus 9.9% for 2001. Expenditures during 2002 for property additions were $253.5 million, which represented 3.1% of current-year net sales compared with 3.7% in 2001. For 2003, expenditures for property additions are currently expected to remain at approximately 3% of net sales. Our measure of full-year 2002 cash flow (defined as net cash provided by operating activities reduced by expenditures for property additions) was $746.4 million and, excluding the after-tax impact of aforementioned year-end voluntary benefit plan contributions, would have been approximately one billion dollars. As a result of this stronger-than-expected cash flow, in December 2002, we made voluntary contributions to several of our major U.S. and U.K. pension and health care plans, totaling $370 million on a pretax basis. Despite these contributions, several of our pension plans experienced shortfalls in market values of trust assets versus the year-end 2002 accounting measurement of accumulated obligation. As a result of this condition, we were required to record on our year-end 2002 balance Kellogg Company 25 sheet a reduction in equity of approximately $306 million. This adjustment had no effect on our earnings, nor our ability to meet current debt covenants and maintain current debt ratings, and is not expected to affect our liquidity or capital resources. Primarily to offset dilution from outstanding employee stock options, our Board of Directors authorized management to repurchase up to $150 million of Kellogg common stock during 2002. Under this authorization, we paid $101 million during 2002 to repurchase approximately 3.1 million shares. The Board has authorized management to repurchase up to $250 million of stock during 2003 to offset or partially offset issuances under employee benefit programs. Subsequent to the Keebler acquisition in March 2001, we have repaid over one billion dollars of debt incurred for this purpose, which reduced our commercial paper program to approximately 2% of our total debt balance by mid-2002. During September 2002, we issued $400 million of U.S. commercial paper and redeemed $300.7 million of fixed rate Notes due April 2003. As of December 28, 2002, we had entered into forward interest rate contracts to fix the Treasury component of the coupon rate on $200 million notional amount of long-term debt to be issued in 2003, as a replacement for other maturing debt. At year-end 2002, these contracts were unfavorable to market by approximately 25 basis points. We believe that we will be able to meet our interest and principal repayment obligations and maintain our debt covenants for the foreseeable future, while still meeting our operational needs through our strong cash flow, our program of issuing commercial paper, and maintaining credit facilities on a global basis. Our significant long-term debt issues do not contain acceleration of maturity clauses that are dependent on credit ratings. A change in our Company's credit ratings could limit its access to the U.S. commercial paper market and/or increase the cost of refinancing long-term debt in the future. However, even under these circumstances, we would continue to have access to our credit facilities, which are in amounts sufficient to cover the outstanding commercial paper balance and debt principal repayments through 2003. OFF-BALANCE SHEET ARRANGEMENTS AND OTHER OBLIGATIONS OFF-BALANCE SHEET ARRANGEMENTS Our off-balance sheet arrangements are generally limited to future payments under noncancelable operating leases totaling approximately $302 million at year-end 2002, residual value guarantees and secondary liabilities on operating leases of approximately $14 million, and third party loan guarantees as discussed in the following paragraph. Our Keebler subsidiary is guarantor on loans to independent contractors for the purchase of DSD route franchises. At year-end 2002, there were total loans outstanding of $14.1 million to 526 franchisees. Related to this arrangement, our Company has established a five-year renewable loan facility and servicing arrangement up to $15.0 million with a financial institution. We have the right to revoke and resell the route franchises in the event of default or any other breach of contract by franchisees. Revocations have been infrequent. Our maximum potential future payments under these guarantees are limited to the outstanding loan principal balance plus unpaid interest. At December 28, 2002, we had not recorded any liability related to this arrangement. During December 2002, the FASB issued Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This interpretation clarifies the requirement for recognition of a liability by a guarantor at the inception of the guarantee, based on the fair value of the non-contingent obligation to perform. This interpretation must be applied prospectively to guarantees entered into or modified after December 31, 2002. Accordingly, we will recognize the fair value of guarantees associated with new loans to DSD route franchisees issued beginning in 2003. These amounts are expected to be insignificant. During January 2003, the FASB issued Interpretation No. 46 "Consolidation of Variable Interest Entities." Under previous practice, entities were included in consolidated financial statements based on controlling voting interests. Under this interpretation, previously unconsolidated entities (often referred to as "special purpose entities") will be included in the consolidated financial statements of the "primary beneficiary" as a result of non-voting financial interests which are established through contractual or other means. For variable interest entities created after January 31, 2003, this interpretation is effective immediately. For any pre-existing variable interest entities, this interpretation would be effective beginning with our Company's fiscal 2003 third quarter. We continue to examine this new literature, but do not currently believe it will be applicable to any existing financial arrangement of our Company. CONTRACTUAL OBLIGATIONS The following table summarizes future estimated cash payments to be made under existing long-term contractual obligations. Further information on debt obligations is contained in Note 7 of Notes to Consolidated Financial Statements. Further information on lease obligations is contained in Note 6.
============================================================================================ Contractual obligations Payments due by period ------------------------------------------------------------- 2008 and (millions) Total 2003 2004-2005 2006-2007 beyond -------------------------------------------------------------------------------------------- Long-term debt (a) $8,869.5 $1,097.4 $1,419.9 $1,476.1 $4,876.1 Capital leases 7.0 1.5 3.3 2.2 -- Operating leases 301.6 92.0 94.3 62.0 53.3 Other long-term (b) 171.7 60.3 101.4 10.0 -- Total $9,349.8 $1,251.2 $1,618.9 $1,550.3 $4,929.4 ============================================================================================
(a) Includes interest payments on significant fixed rate debt issuances outstanding at December 28, 2002. (b) Consists principally of minimum annual payments under long-term co-marketing agreements. Certain of these agreements also define minimum activity levels of an unspecified dollar amount for packaging innovation, advertising, and promotion, for which we have estimated and included the fixed cost component in the amounts above. 26 Kellogg Company CONTINGENT OBLIGATIONS Our Company has provided various representations, warranties, and other standard indemnifications in agreements to sell business assets or lease facilities over the past several years. Additionally, our Company is involved in various claims, including environmental and employment matters, arising in the ordinary course of business. We do not believe that any of these commitments or contingencies represents material adverse exposures to our Company's financial position or future results. SIGNIFICANT ACCOUNTING POLICIES Our significant accounting policies are discussed in Note 1 of Notes to Consolidated Financial Statements. Our critical accounting policies, which require significant judgments and estimates, are generally limited to those governing the amount and timing of recognition of consumer promotional expenditures and the assessment of the carrying value of goodwill and other intangible assets. Our promotional activities are conducted either through the retail trade or directly with consumers and involve in-store displays; feature price discounts on our products; consumer coupons, contests, and loyalty programs; and similar activities. The costs of these activities are generally recognized at the time the related revenue is recorded, which normally precedes the actual cash expenditure. The recognition of these costs therefore requires management judgment regarding the volume of promotional offers that will be redeemed by either the retail trade or consumer. These estimates are made using various techniques including historical data on performance of similar promotional programs. Differences between estimated expense and actual redemptions are normally insignificant and recognized as a change in management estimate in a subsequent period. However, as our Company's total promotional expenditures represented nearly 30% of 2002 net sales, the likelihood exists of materially different reported results if different assumptions or conditions were to prevail. Beginning in 2002, we follow SFAS No. 142 in evaluating impairment of goodwill and other intangible assets. Under this standard, goodwill impairment testing first requires a comparison between the carrying value and fair value of a reporting unit with associated goodwill. Carrying value is based on the assets and liabilities associated with the operations of that reporting unit, which often requires allocation of shared or corporate items among reporting units. The fair value of a reporting unit is based primarily on our assessment of profitability multiples likely to be achieved in a theoretical sale transaction. Similarly, impairment testing of other intangible assets requires a comparison of carrying value to fair value of that particular asset. Fair values of non-goodwill intangible assets are based primarily on projections of future cash flows to be generated from that asset. For instance, cash flows related to a particular trademark would be based on a projected royalty stream attributable to branded product sales. These estimates are made using various inputs including historical data, current and anticipated market conditions, management plans, and market comparables. At December 28, 2002, intangible assets, net, were $5.1 billion, consisting primarily of goodwill, trademarks, and DSD delivery system associated with the Keebler acquisition. While we currently believe that the fair value of all of our intangibles exceeds carrying value, materially different assumptions regarding future performance of our snacks business could result in significant impairment losses. FUTURE OUTLOOK As we begin 2003, our Company faces several important challenges, including: _ higher employee benefits expense; _ significant increases in the prices of certain grains, cocoa, and packaging; _ increased cost and reduced availability of certain types of insurance such as product recall and tampering, and earthquake; _ economic volatility in Latin America; and _ a fundamental change in strategy for our snacks business as discussed further below. Despite these challenges, our Company should be able to generate high single-digit earnings per share growth for 2003, excluding the impact of favorable legal settlements in the first quarter of 2002. We believe these cost increases and risks can be largely offset with pricing and mix improvements, a series of supply chain productivity initiatives, and the momentum in operating performance and cash flow expansion we established in 2002. Regarding our snacks business, we are in the process of restructuring this business for the next phase of its life cycle. This restructuring entails a change from an "acquire-and-integrate strategy" followed successfully by Keebler prior to our acquisition of that company, to a strategy of sustainable, organic growth. Although we believe we are executing well, the success of this new strategy depends on our ability to enhance brand-building capabilities both in consumer marketing and innovation, requiring considerable changes in processes and personnel. As we accelerate this transition during 2003, we plan to make significant investments in this business. Despite significant benefit plan contributions in 2002, we expect to experience double-digit increases in employee pension and health care expense during 2003, attributable principally to rapidly rising U.S. health care costs, the impact of changes in several actuarial assumptions versus 2002, and amortization of experience losses. Based on recent and projected market conditions, we have decided to reduce our long-term rate of return on major plan assets from 10.5% to 9.3% for 2003. To review our long-term rate of return on an annual basis, we work with third party financial consultants to model expected returns over a 20-year investment horizon with respect to the investment mix of our major plans, which currently consist of approximately 70% equities, 15% investment grade bonds, and 15% high-yielding bonds and other investments. The return assumptions used reflect a Kellogg Company 27 combination of rigorous historical performance analysis and forward-looking views of the financial markets as indicated by yields on long-term bonds and price-earnings ratios of the major stock market indices. With respect to our investment mix, the simulations of this model during 2002 resulted in a mean return of 8.5% and a 75th percentile return of 10.4%. This model does not incorporate a premium for active management of trust investments which, according to our historical analysis, is expected to add at least 100 basis points to the long-term performance of our plan assets versus the mean return of the model. Taking into account this premium, we currently believe that 9.3% is an appropriate reflection of the expected long-term performance of our trust investments. Any future variance between the assumed and actual rates of return on our plan assets is currently expected to have an insignificant impact on our earnings for any particular year, due to our election to determine fair value of plan assets based on calculated value over a five-year period and the process of amortizing experience gains and losses using a declining-balance method over the average remaining service period of active employees. For instance, a 100 basis point shortfall in actual versus assumed performance of all of our plan assets in year one would result in an arising experience loss of approximately $20 million. The unfavorable impact on earnings in year two would be less than $2 million. Approximately 80% of this experience loss would be recovered through earnings at the end of year 20. In addition to reducing the asset return rate, we also addressed the health care cost trend rates and discount rates applicable to the year-end 2002 plan valuations. While our initial trend rate for 2003 of 8% is consistent with our recent experience, we have decided to increase our ultimate assumed cost trend rate for U.S. retiree health care benefits from 4.5% to 5%, based on current economic views on long-term health care cost inflation. Lastly, based on prevailing rates on high quality debt securities, we reduced the discount rate used to measure our year-end 2002 plan obligations by at least 25 basis points in most of our major jurisdictions, which include the United States, United Kingdom, and Canada. Our global weighted average discount rate at year-end 2002 was 6.6% versus 7% at year-end 2001. Due primarily to stock market declines over the past several years, we have experienced shortfalls in actual versus expected performance of trust investments. Combined with the unfavorable impact of falling interest rates on measurement of our benefit obligations during the same time period, we have accumulated significant experience losses, which must be amortized as a component of benefits expense in future years. For 2003, we currently expect incremental amortization of approximately $20 million. Assuming actual future experience is consistent with our current assumptions, incremental amortization of accumulated experience losses during each of the next several years would be approximately equivalent to the 2003 amount. FORWARD-LOOKING STATEMENTS Our Management's Discussion and Analysis, and other parts of this Annual Report contain "forward-looking statements" with projections concerning, among other things, our strategy and plans; growth, margins, and profitability; products and promotions; exit plans and costs related to the Keebler acquisition; the impact of accounting changes; our ability to meet interest and debt principal repayment obligations; future common stock repurchases; effective income tax rate; cash flow; working capital; property addition expenditures; interest expense, commodity prices, health care and pension costs; and realizability of the carrying value of intangibles and other assets. Forward-looking statements include predictions of future results or activities and may contain the words "expect," "believe," "will," "will deliver," "anticipate," "project," "should," or words or phrases of similar meaning. Our actual results or activities may differ materially from these predictions. In particular, future results or activities could be affected by factors related to the Keebler acquisition, including integration problems, failures to achieve savings, unanticipated liabilities, and the substantial amount of debt incurred to finance the acquisition, which could, among other things, hinder our ability to adjust rapidly to changing market conditions, make us more vulnerable in the event of a downturn, and place us at a competitive disadvantage relative to less-leveraged competitors. In addition, our future results could be affected by a variety of other factors, including: _ competitive conditions in our markets; _ marketing spending levels and pricing actions of competitors; _ the impact of competitive conditions, marketing spending, and/or incremental pricing actions on actual volumes and product mix; _ effectiveness of advertising and marketing spending or programs; _ the success of innovations and new product introductions; _ the availability of and interest rates on short-term financing; _ actual market performance of benefit plan trust investments; _ the levels of spending on systems initiatives, properties, business opportunities, integration of acquired businesses, and other general and administrative costs; _ commodity prices and labor costs; _ changes in consumer behavior and preferences; _ changes in U.S. or foreign regulations affecting the food industry; _ the success of productivity improvements; _ the success of business transitions; _ U.S. and foreign economic conditions, including currency conversion controls and rate fluctuations; _ legal factors; and, _ business disruption or other losses from terrorist acts or political unrest, or responses to them. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to publicly update them. 28 Kellogg Company KELLOGG COMPANY AND SUBSIDIARIES
SELECTED FINANCIAL DATA (in millions, except per share data and number of employees) ==================================================================================================================================== 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------------------------------------------------------------ OPERATING TRENDS Net sales (d) $ 8,304.1 $ 7,548.4 $ 6,086.7 $ 6,156.5 $ 6,110.5 Gross profit as a % of net sales (d) 45.0% 44.2% 44.1% 45.2% 45.3% Depreciation 346.9 331.0 275.6 273.6 261.8 Amortization 1.5 107.6 15.0 14.4 16.3 Advertising expense 588.7 519.2 604.2 674.1 695.3 Research and development expense 106.4 110.2 118.4 104.1 121.9 Operating profit (a) (e) 1,508.1 1,167.9 989.8 828.8 895.1 Operating profit as a % of net sales 18.2% 15.5% 16.3% 13.5% 14.6% Interest expense 391.2 351.5 137.5 118.8 119.5 Earnings before extraordinary loss and cumulative effect of accounting change (a) (b) (e) 720.9 482.0 587.7 338.3 502.6 Average shares outstanding: Basic 408.4 406.1 405.6 405.2 407.8 Diluted 411.5 407.2 405.8 405.7 408.6 Earnings per share before extraordinary loss and cumulative effect of accounting change (a) (b) (e): Basic 1.77 1.19 1.45 .83 1.23 Diluted 1.75 1.18 1.45 .83 1.23 ------------------------------------------------------------------------------------------------------------------------------------ CASH FLOW TRENDS Net cash provided from operating activities $ 999.9 $ 1,132.0 $ 880.9 $ 795.2 $ 719.7 Capital expenditures 253.5 276.5 230.9 266.2 373.9 Net cash provided from operating activities reduced by capital expenditures 746.4 855.5 650.0 529.0 345.8 Net cash used in investing activities (188.8) (4,143.8) (379.3) (244.2) (398.0) Net cash provided from (used in) financing activities (944.4) 3,040.2 (441.8) (527.6) (358.3) Interest coverage ratio (c) 4.8 4.5 9.4 7.9 9.9 ------------------------------------------------------------------------------------------------------------------------------------ CAPITAL STRUCTURE TRENDS Total assets $ 10,219.3 $ 10,368.6 $ 4,886.0 $ 4,808.7 $ 5,051.5 Property, net 2,840.2 2,952.8 2,526.9 2,640.9 2,888.8 Short-term debt 1,197.3 595.6 1,386.3 521.5 621.5 Long-term debt 4,519.4 5,619.0 709.2 1,612.8 1,614.5 Shareholders' equity 895.1 871.5 897.5 813.2 889.8 ------------------------------------------------------------------------------------------------------------------------------------ SHARE PRICE TRENDS Stock price range $ 29-37 $ 25-34 $ 21-32 $ 30-42 $ 30-50 Cash dividends per common share 1.010 1.010 .995 .960 .920 ------------------------------------------------------------------------------------------------------------------------------------ Number of employees 25,676 26,424 15,196 15,051 14,498 ====================================================================================================================================
(a) Operating profit for 2001 includes restructuring charges, net of credits, of $33.3 ($20.5 after tax or $.05 per share). Operating profit for 2000 includes restructuring charges of $86.5 ($64.2 after tax or $.16 per share). Operating profit for 1999 includes restructuring charges of $244.6 ($156.4 after tax or $.40 per share). Earnings before extraordinary loss and accounting change for 1999 include disposition-related charges of $168.5 ($111.5 after tax or $.27 per share). Operating profit for 1998 includes restructuring charges of $70.5 ($46.3 after tax or $.12 per share). Refer to Management's Discussion and Analysis beginning on page 24 and Note 3 within Notes to Consolidated Financial Statements for further explanation of charges for years 2000-2001. (b) Earnings before extraordinary loss and cumulative effect of accounting change for 2001 exclude the effect of a charge of $7.4 after tax ($.02 per share) for extinguishment of debt and a charge of $1.0 after tax to adopt SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". (c) Interest coverage ratio is calculated based on earnings before interest expense, income taxes, depreciation, and amortization, divided by interest expense. (d) 1998-2001 net sales restated for the retroactive application of EITF No. 01-09. Refer to Note 1 within Notes to Consolidated Financial Statements for further information. (e) Results for 2001 include $103.6 ($85.0 after tax or $.21 per share) of amortization which has been eliminated by SFAS No. 142 on a pro forma basis. Amortization in pre-2001 years was insignificant. Refer to Note 1 for further information. Kellogg Company 29 KELLOGG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS ==================================================================================================================================== (millions, except per share data) 2002 2001 2000 ------------------------------------------------------------------------------------------------------------------------------------ NET SALES $ 8,304.1 $ 7,548.4 $ 6,086.7 ------------------------------------------------------------------------------------------------------------------------------------ Cost of goods sold 4,569.0 4,211.4 3,401.7 Selling, general, and administrative expense 2,227.0 2,135.8 1,608.7 Restructuring charges -- 33.3 86.5 ------------------------------------------------------------------------------------------------------------------------------------ OPERATING PROFIT $ 1,508.1 $ 1,167.9 $ 989.8 ------------------------------------------------------------------------------------------------------------------------------------ Interest expense 391.2 351.5 137.5 Other income (expense), net 27.4 (12.3) 15.4 ------------------------------------------------------------------------------------------------------------------------------------ EARNINGS BEFORE INCOME TAXES, EXTRAORDINARY LOSS, AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE $ 1,144.3 $ 804.1 $ 867.7 Income taxes 423.4 322.1 280.0 ------------------------------------------------------------------------------------------------------------------------------------ EARNINGS BEFORE EXTRAORDINARY LOSS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE $ 720.9 $ 482.0 $ 587.7 ------------------------------------------------------------------------------------------------------------------------------------ Extraordinary loss (net of tax) -- (7.4) -- Cumulative effect of accounting change (net of tax) -- (1.0) -- ------------------------------------------------------------------------------------------------------------------------------------ NET EARNINGS $ 720.9 $ 473.6 $ 587.7 ------------------------------------------------------------------------------------------------------------------------------------ PER SHARE AMOUNTS: Earnings before extraordinary loss and cumulative effect of accounting change: Basic $ 1.77 $ 1.19 $ 1.45 Diluted 1.75 1.18 1.45 Net earnings: Basic 1.77 1.17 1.45 Diluted 1.75 1.16 1.45 ====================================================================================================================================
==================================================================================================================================== CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY ==================================================================================================================================== Accumulated other Total Total Common stock Capital in Treasury stock comprehen- share- comprehen- ---------------- excess of Retained ------------------ sive holders sive (millions) shares amount par value earnings shares amount income equity income ------------------------------------------------------------------------------------------------------------------------------------ Balance, January 1, 2000 415.5 $103.8 $104.5 $1,317.2 10.0 ($ 380.9) ($ 331.4) $ 813.2 Net earnings 587.7 587.7 $ 587.7 Dividends (403.9) (403.9) Other comprehensive income (103.9) (103.9) (103.9) Stock options exercised and other (2.5) (.2) 6.9 4.4 ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2000 415.5 $103.8 $102.0 $1,501.0 9.8 ($ 374.0) ($ 435.3) $ 897.5 $ 483.8 -------- Net earnings 473.6 473.6 473.6 Dividends (409.8) (409.8) Other comprehensive income (116.1) (116.1) (116.1) Stock options exercised and other (10.5) (.1) (1.0) 36.9 26.3 ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2001 415.5 $103.8 $ 91.5 $1,564.7 8.8 ($ 337.1) ($ 551.4) $ 871.5 $ 357.5 -------- Common stock repurchases 3.1 (101.0) (101.0) Net earnings 720.9 720.9 720.9 Dividends (412.6) (412.6) Other comprehensive income (302.0) (302.0) (302.0) Stock options exercised and other (41.6) (4.3) 159.9 118.3 ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 28, 2002 415.5 $103.8 $ 49.9 $1,873.0 7.6 ($278.2) ($853.4) $895.1 $418.9 ====================================================================================================================================
Refer to Notes to Consolidated Financial Statements. 30 Kellogg Company KELLOGG COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET ==================================================================================================================== (millions, except share data) 2002 2001 -------------------------------------------------------------------------------------------------------------------- CURRENT ASSETS Cash and cash equivalents $ 100.6 $ 231.8 Accounts receivable, net 741.0 762.3 Inventories 603.2 574.5 Other current assets 318.6 333.4 -------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS $ 1,763.4 $ 1,902.0 -------------------------------------------------------------------------------------------------------------------- PROPERTY, NET 2,840.2 2,952.8 OTHER ASSETS 5,615.7 5,513.8 -------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 10,219.3 $ 10,368.6 ==================================================================================================================== CURRENT LIABILITIES Current maturities of long-term debt $ 776.4 $ 82.3 Notes payable 420.9 513.3 Accounts payable 619.0 577.5 Other current liabilities 1,198.6 1,034.5 -------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES $ 3,014.9 $ 2,207.6 -------------------------------------------------------------------------------------------------------------------- LONG-TERM DEBT 4,519.4 5,619.0 OTHER LIABILITIES 1,789.9 1,670.5 SHAREHOLDERS' EQUITY Common stock, $.25 par value, 1,000,000,000 shares authorized Issued: 415,451,198 shares in 2002 and 2001 103.8 103.8 Capital in excess of par value 49.9 91.5 Retained earnings 1,873.0 1,564.7 Treasury stock at cost: 7,598,923 shares in 2002 and 8,840,028 shares in 2001 (278.2) (337.1) Accumulated other comprehensive income (853.4) (551.4) -------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY $ 895.1 $ 871.5 -------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 10,219.3 $ 10,368.6 ====================================================================================================================
Refer to Notes to Consolidated Financial Statements. Kellogg Company 31 KELLOGG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS =========================================================================================================== (millions) 2002 2001 2000 ----------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net earnings $ 720.9 $ 473.6 $ 587.7 Adjustments to reconcile net earnings to operating cash flows: Depreciation and amortization 348.4 438.6 290.6 Deferred income taxes 111.2 71.5 (1.4) Restructuring charges, net of cash paid - 31.2 62.5 Other .7 (66.0) (1.2) Pension and other postretirement benefit contributions (446.6) (76.3) (84.3) Changes in operating assets and liabilities 265.3 259.4 27.0 ----------------------------------------------------------------------------------------------------------- NET CASH PROVIDED FROM OPERATING ACTIVITIES $ 999.9 $ 1,132.0 $ 880.9 ----------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Additions to properties ($ 253.5) ($ 276.5) ($ 230.9) Acquisitions of businesses (2.2) (3,858.0) (137.2) Dispositions of businesses 60.9 - - Property disposals 6.0 10.1 4.8 Other - (19.4) (16.0) ----------------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES ($ 188.8) ($ 4,143.8) ($ 379.3) ----------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net increase (reduction) of notes payable, with maturities less than ($ 226.2) ($ 154.0) $ 290.5 or equal to 90 days Issuances of notes payable, with maturities greater than 90 days 354.9 549.6 3.5 Reductions of notes payable, with maturities greater than 90 days (221.1) (365.6) (331.6) Issuances of long-term debt - 5,001.4 - Reductions of long-term debt (439.3) (1,608.4) (4.8) Net issuances of common stock 100.9 26.4 4.5 Common stock repurchases (101.0) - - Cash dividends (412.6) (409.8) (403.9) Other - .6 - ----------------------------------------------------------------------------------------------------------- NET CASH PROVIDED FROM (USED IN) FINANCING ACTIVITIES ($ 944.4) $ 3,040.2 ($ 441.8) ----------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash 2.1 (1.0) (6.0) ----------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents ($ 131.2) $ 27.4 $ 53.8 Cash and cash equivalents at beginning of year 231.8 204.4 150.6 ----------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 100.6 $ 231.8 $ 204.4 ===========================================================================================================
Refer to Notes to Consolidated Financial Statements. 32 Kellogg Company KELLOGG COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 AND OTHER LONG-LIVED ASSETS Fixed assets are recorded at cost and depreciated over estimated useful lives using straight-line methods for financial reporting and accelerated methods for tax reporting. Cost includes an amount of interest associated with significant capital projects. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of Long-lived Assets" on January 1, 2002. This standard is generally effective for the Company on a prospective basis. SFAS No. 144 clarifies and revises existing guidance on accounting for impairment of plant, property, and equipment, amortized intangibles, and other long-lived assets not specifically addressed in other accounting literature. Significant changes include 1) establishing criteria beyond those previously specified in existing literature for determining when a long-lived asset is held for sale, and 2) requiring that the depreciable life of a long-lived asset to be abandoned is revised. SFAS No. 144 also broadens the presentation of discontinued operations to include a component of an entity (rather than only a segment of a business). GOODWILL AND OTHER INTANGIBLE ASSETS The Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets" on January 1, 2002. This standard provides accounting and disclosure guidance for acquired intangibles. Under this standard, goodwill and "indefinite-lived" intangibles are no longer amortized, but are tested at least annually for impairment. Goodwill impairment testing first requires a comparison between the carrying value and fair value of a reporting unit, including goodwill allocated to it. If carrying value exceeds fair value, goodwill is considered impaired. The amount of impairment loss is measured as the difference between carrying value and implied fair value of goodwill, which is determined in the same manner as the amount of goodwill recognized in a business combination. Impairment testing for non-amortized intangibles requires a comparison between the fair value and carrying value of the intangible asset. If carrying value exceeds fair value, the intangible is considered impaired and is reduced to fair value. The Company uses various market valuation techniques to determine fair value of goodwill and other intangible assets, primarily discounted cash flow models and profitability-based multiples. Transitional impairment tests of goodwill and non-amortized intangibles were required to be performed upon adoption of SFAS No. 142, with any recognized impairment loss reported as the cumulative effect of an accounting change in the first period of adoption. The Company was not required to recognize any impairment losses under these transitional tests. SFAS No. 142 also provides separability criteria for recognizing intangible assets apart from goodwill. Under these provisions, assembled workforce is no longer considered a separate intangible. Accordingly, effective January 1, 2002, the Company reclassified approximately $46 million from other intangibles to goodwill. Refer to Note 15 for further information on the Company's goodwill and other intangible assets. For periods prior to 2002, intangible assets were amortized on a straight-line basis over the estimated periods benefited, generally 40 years for goodwill and periods ranging from 5 to 40 years for other intangible assets. The realizability of goodwill and other intangibles was evaluated periodically when events or circumstances indicated a possible inability to recover the carrying amount. Evaluation was based on undiscounted cash flow projections over the remaining life of the asset. An excess of carrying value over cash flows resulted in recognition of an impairment loss. The amount of the loss was based on the difference between carrying value and fair value of the asset, as measured by market comparables or discounted cash flows in the absence of market data. REVENUE RECOGNITION AND MEASUREMENT The Company recognizes sales upon delivery of its products to customers net of applicable provisions for discounts, returns, and allowances. Beginning January 1, 2002, the Company has applied the consensus reached by the Emerging Issues Task Force (EITF) of the FASB in Issue No. 01-09 "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products." Under this consensus, generally, cash consideration is classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. Non-cash consideration is classified as a cost of sales. Kellogg Company 33 As a result of applying this consensus, the Company has reclassified promotional payments to its customers and the cost of consumer coupons and other cash redemption offers from selling, general, and administrative expense (SGA) to net sales. The Company has reclassified the cost of promotional package inserts and other non-cash consideration from SGA to cost of goods sold. Prior-period financial statements have been reclassified to comply with this guidance. ADVERTISING The costs of advertising are generally expensed as incurred and are classified within SGA. STOCK COMPENSATION The Company follows Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," in accounting for its employee stock options and other stock-based compensation. Under APB No. 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 No. 123 "Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure." Refer to Note 8 for further information. DERIVATIVES AND HEDGING TRANSACTIONS The Company adopted SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" on January 1, 2001. This statement requires all derivative instruments to be recorded on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. Upon adoption, the Company reported a charge to earnings of $1.0 million (net of tax benefit of $.6 million) and a charge to other comprehensive income of $14.9 million (net of tax benefit of $8.6 million) in order to recognize the fair value of derivative instruments as either assets or liabilities on the balance sheet. The charge to earnings relates to the component of the derivative instruments' net loss that has been excluded from the assessment of hedge effectiveness. Refer to Note 12 for further information. For periods prior to 2001, the Company accounted for derivatives and hedging transactions in a manner similar to the provisions of SFAS No. 133, except that 1) unrealized gains and losses related to hedges of forecasted transactions were deferred as assets or liabilities rather than included in other comprehensive income, and 2) the fair values of certain financial derivatives such as interest rate swaps were carried off-balance sheet. RECENTLY ISSUED PRONOUNCEMENTS Accounting for exit costs The Company has adopted SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal," with respect to exit or disposal activities initiated after December 31, 2002. This statement is intended to achieve consistency in timing of recognition between exit costs, such as one-time employee separation benefits and contract termination payments, and all other costs. Under pre-existing literature, certain costs associated with exit activities were recognized when management committed to a plan. Under SFAS No. 146, costs are recognized when a liability has been incurred under general concepts. For instance, under pre-existing literature, plant closure costs would be accrued at the plan commitment date. Under SFAS No. 146, these costs would be recognized as closure activities are performed. These provisions could be expected to have the general effect of delaying recognition of certain costs related to restructuring programs. However, management does not currently expect adoption of this standard to have a significant impact on the Company's 2003 financial results. Guarantees With respect to guarantees entered into or modified after December 31, 2002, the Company has applied guidance contained in FASB Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This interpretation clarifies the requirement for recognition of a liability by a guarantor at the inception of the guarantee, based on the fair value of the non-contingent obligation to perform. Management does not currently expect application of this guidance to have a significant impact on the Company's 2003 financial results. Extinguishment of debt Net earnings for 2001 include an extraordinary loss of $7.4 million, net of tax benefit of $4.2 million ($.02 per share), related to the extinguishment of $400 million of long-term debt. Effective with its 2003 fiscal year, the Company adopted SFAS No. 145, a technical corrections pronouncement which, in part, rescinds SFAS No. 4 "Reporting Gains and Losses from Extinguishment of Debt." Under SFAS No. 145, generally, debt extinguishments will no longer be classified as extraordinary items. Accordingly, the extraordinary loss for 2001 will be reclassified to conform to the presentation for 2003 and subsequent years. Variable interest entities During January 2003, the FASB issued Interpretation No. 46 "Consolidation of Variable Interest Entities." Under previous practice, entities were included in consolidated financial statements based on controlling voting interests. Under this interpretation, previously un-consolidated entities (often referred to as "special purpose entities") will be included in the consolidated financial statements of the "primary beneficiary" as a result of non-voting financial interests which are established through contractual or other means. For variable interest entities created after January 31, 2003, this interpretation is effective immediately. For any pre-existing variable interest entities, this interpretation would be effective beginning with the Company's fiscal 2003 third quarter. Management continues to examine this new literature, but does not currently believe it will be applicable to any existing financial arrangement of the Company. 34 Kellogg Company USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 2 ACQUISITIONS AND DISPOSITIONS KEEBLER ACQUISITION On March 26, 2001, the Company acquired Keebler Foods Company in a cash transaction valued at $4.56 billion. The acquisition was accounted for under the purchase method and was financed through a combination of short-term and long-term debt. The components of intangible assets included in the final allocation of purchase price are presented in the following table. During 2001, these intangibles were amortized based on an estimated useful life of 40 years. As a result of the Company's adoption of SFAS No. 142 on January 1, 2002 (refer to Note 1), these intangibles are no longer amortized after 2001, but are subject to annual impairment reviews.
==================================================== (millions) ---------------------------------------------------- Trademarks and tradenames $ 1,310.0 Direct store door (DSD) delivery system 590.0 Goodwill 2,938.5 ---------------------------------------------------- $ 4,838.5 ====================================================
The final purchase price allocation includes $71.3 million of liabilities related to management's plans, as of the acquisition date, to exit certain activities and operations of the acquired company, as presented in the table below. Cash outlays related to these exit plans were approximately $28 million in 2001 and approximately $24 million in 2002, with the remaining amounts to be spent principally during 2003.
================================================================================================================== Lease & other Employee Employee contract Facility closure (millions) severance benefits relocation termination costs Total ------------------------------------------------------------------------------------------------------------------ Total reserve at acquisition date: Original estimate $ 59.3 $ 8.6 $12.3 $10.4 $ 90.6 Purchase accounting adjustments (10.3) (7.1) (.5) (1.4) (19.3) ------------------------------------------------------------------------------------------------------------------ Adjusted $ 49.0 $ 1.5 $11.8 $ 9.0 $ 71.3 Amounts utilized during 2001 (23.9) (.8) (.4) (2.9) (28.0) Amounts utilized during 2002 (17.9) (.1) (1.8) (4.2) (24.0) ------------------------------------------------------------------------------------------------------------------ REMAINING RESERVE AT DECEMBER 28, 2002 $ 7.2 $ .6 $ 9.6 $ 1.9 $ 19.3 ==================================================================================================================
Exit plans are being announced as individual initiatives are implemented. In August 2002, management announced plans to consolidate certain functions in Battle Creek, Michigan, primarily research, technology, and financial services. As a result, approximately 70 positions in Elmhurst, Illinois, were relocated or eliminated. During November 2002, the Company commenced the process of consolidating ice cream cone and pie crust manufacturing operations from several facilities to a single facility in Chicago, Illinois. Other major initiatives begun in 2002 included the reconfiguration of Keebler's DSD system in the southeastern United States to accommodate Kellogg snack product volume, which has resulted in early termination of leases on approximately 100 small vans and separation of approximately 85 sales representatives and support personnel. Exit plans implemented during 2001 included separation of approximately 90 Keebler administrative employees and the closing of a bakery in Denver, Colorado, eliminating approximately 440 employee positions. During June 2001, the Company communicated plans to transfer portions of Keebler's Grand Rapids, Michigan, bakery production to other plants in the United States during the next 12 months. As a result, approximately 150 employee positions were eliminated, partly through a voluntary retirement program. During April 2002, the Company sold certain assets of Keebler's Bake-Line private-label unit, including a bakery in Marietta, Oklahoma, to Atlantic Baking Group, Inc. for approximately $65 million in cash and a $10 million note to be paid at a later date. In January 2003, the Company sold additional private-label operations for approximately $14 million in cash. For both of these transactions, the carrying value of net assets sold, including allocated goodwill, approximated the net sales proceeds. The following table includes the unaudited pro forma combined results as if Kellogg Company had acquired Keebler Foods Company as of the beginning of either 2001 or 2000, instead of March 26, 2001. Net sales have been restated for the retroactive application of EITF Issue No. 01-09 (refer to Note 1) effective January 1, 2002.
================================================================================ (millions, except per share data) 2001 2000 -------------------------------------------------------------------------------- Net sales $ 8,049.8 $ 8,270.1 Earnings before extraordinary loss and cumulative effect of accounting change $ 438.0 $ 517.9 Net earnings $ 429.6 $ 517.9 Net earnings per share (basic and diluted) $ 1.06 $ 1.28 ================================================================================
The pro forma results include amortization of the intangibles presented above and interest expense on debt assumed issued to finance the purchase. The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been completed as of the beginning of each of the fiscal periods presented, nor are they necessarily indicative of future consolidated results. OTHER ACQUISITIONS During 2000, the Company paid cash for several business acquisitions. In January, the Company purchased certain assets and liabilities of the Mondo Baking Company Division of Southeastern Mills, Inc., a convenience foods manufacturing operation, for approximately $93 million, including related acquisition costs. In July, the Company purchased certain assets and liabilities of The Healthy Snack People business, an Australian convenience foods operation, for approximately $12 million, including related acquisition costs. In June, the Company acquired the outstanding stock of Kashi Company, a U.S. natural foods company. In May 2002, the Company paid additional contingent purchase price of $2 million, bringing the total purchase price, including related acquisition costs, to approximately $35 million. Kellogg Company 35 NOTE 3 RESTRUCTURING AND OTHER CHARGES Cost of goods sold for 2002 includes an impairment loss of $5.0 million related to the Company's manufacturing facility in China, representing a decline in real estate market value subsequent to an original impairment loss recognized for this property in 1997. Management is now in the process of selling this facility and currently believes the carrying value reflects fair value less cost to sell. During the past several years, management has commenced major productivity and operational streamlining initiatives in an effort to optimize the Company's cost structure and align resources with the Company's growth strategy. The incremental costs of these programs have been reported during these years as restructuring charges. Specifically, during 2000, management adopted key operating principles that emphasize a stricter prioritization for resource allocation to the United States and the Company's other core markets. In conjunction with this strategy, the Company was reorganized from four operating areas into two divisions - U.S. and International. As a result, management initiated restructuring actions around the world to support this strategy and organization, including staff reductions in its global supply chain and innovation organization, rationalization of international convenience foods capacity, and restructuring of various non-core markets to improve return on investment. These initiatives resulted in restructuring charges during both 2000 and 2001, as follows:
================================================================================ (millions except per share data) 2001 2000 -------------------------------------------------------------------------------- Restructuring charges $ 48.3 $ 86.5 Credits for reserve adjustments (15.0) -- -------------------------------------------------------------------------------- Net charges $ 33.3 $ 86.5 -------------------------------------------------------------------------------- After-tax impact $ 20.5 $ 64.2 -------------------------------------------------------------------------------- Net earnings per share impact $ .05 $ .16 ================================================================================
The 2001 charges of $48.3 million are related to preparing Kellogg for the Keebler integration and continued actions supporting the Company's growth strategy. Specific initiatives included a headcount reduction of about 30 in U.S. and global Company management, rationalization of product offerings and other actions to combine the Kellogg and Keebler logistics systems, and further reductions in convenience foods capacity in Southeast Asia. Approximately two-thirds of the charges were comprised of asset write-offs with the remainder consisting of employee separation benefits and other cash costs. The 2001 credits of $15.0 million result from adjustments to various restructuring and asset disposal reserves. With numerous multi-year streamlining initiatives nearing completion in late 2001, management conducted an assessment of post-2001 reserve needs, which resulted in net reductions of $8.8 million for cash outlays and $6.2 million for asset disposals. (Asset disposal reserves are reported within Property, net, on the Consolidated Balance Sheet.) The reduction in cash outlays relates primarily to lower-than-anticipated employee severance and asset removal expenditures, and higher-than-anticipated asset sale proceeds. The 2000 charges of $86.5 million consist of $65.2 million for actions supporting the Company's growth strategy and $21.3 million for a supply chain efficiency initiative in Europe. Approximately one-half of the charges for the growth strategy program were comprised of asset write-offs with the remainder consisting primarily of cash costs associated with involuntary employee separation programs. Approximately 500 salaried and hourly positions were eliminated, primarily during the fourth quarter of 2000. The charges for the European supply chain program were comprised principally of voluntary employee retirement and separation benefits. This program resulted in hourly and salaried headcount reductions totaling 190 during 2000. Total cash outlays incurred for restructuring programs were approximately $8 million in 2002, $35 million in 2001, and $68 million in 2000. At the end of 2002, all restructuring programs were complete and remaining reserves of $1.4 million consisted solely of long-term contractual obligations for employee severance. As a result of the Keebler acquisition in March 2001, the Company assumed $14.9 million of reserves for severance and facility closures related to Keebler's ongoing restructuring and acquisition-related synergy initiatives. Approximately $5 million of those reserves were utilized in 2001, with the remainder being attributable primarily to noncancelable lease obligations extending through 2006. The components of the restructuring charges by initiative, as well as reserve balances remaining at year-end 2002, 2001, and 2000, were:
======================================================================================================= U.S. OPERATIONAL Employee retirement STREAMLINING and severance Asset Asset Other (millions) benefits write-offs removal costs(c) Total ------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 1999 $ 21.4 $ -- $ 28.1 $ -- $ 49.5 Amounts utilized during 2000 (20.0) -- (17.4) -- (37.4) ------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2000 $ 1.4 $ -- $ 10.7 $ -- $ 12.1 2001 restructuring credits (1.1) (1.1) (.8) -- (3.0) Amounts utilized during 2001 (.3) 1.1 (8.2) -- (7.4) ------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2001 $ -- $ -- $ 1.7 $ -- $ 1.7 Amounts utilized during 2002 -- -- (1.7) -- (1.7) ------------------------------------------------------------------------------------------------------- Remaining reserve at December 28, 2002 $ -- $ -- $ -- $ -- $ -- =======================================================================================================
======================================================================================================= PAN-EUROPEAN Employee retirement REORGANIZATION and severance Asset Asset Other (millions) benefits(a) write-offs removal costs(c) Total ------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 1999 (b) $ 2.7 $ -- $(1.2) $ -- $ 1.5 2000 restructuring charges 19.6 -- -- 1.7 21.3 Amounts utilized during 2000 (21.3) -- 1.2 (1.7) (21.8) ------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2000 $ 1.0 $ -- $ -- $ -- $ 1.0 Amounts utilized during 2001 (1.0) -- -- -- (1.0) ------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2001 $ -- $ -- $ -- $ -- $ -- =========================================================================================================
36 Kellogg Company
================================================================================================================================ AUSTRALIAN PLANT Employee retirement PRODUCTIVITY PROGRAM and severance Asset Asset Other (millions) benefits write-offs removal costs (c) Total -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 1999 $ 3.1 $ -- $ .6 $ -- $ 3.7 Amounts utilized during 2000 (3.1) -- (.6) -- (3.7) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2000 $ -- $ -- $ -- $ -- $ -- ================================================================================================================================
================================================================================================================================ NORTH AMERICAN OVERHEAD Employee retirement ACTIVITY ANALYSIS and severance Asset Asset Other (millions) benefits write-offs removal costs (c) Total -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 1999 $ 4.2 $ -- $ 1.0 $ -- $ 5.2 Amounts utilized during 2000 (3.1) -- (.5) -- (3.6) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2000 $ 1.1 $ -- $ .5 $ -- $ 1.6 Amounts utilized during 2001 (.8) -- (.3) -- (1.1) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2001 $ .3 $ -- $ .2 $ -- $ .5 Amounts utilized during 2002 (.3) -- (.2) -- (.5) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 28, 2002 $ -- $ -- $ -- $ -- $ -- ================================================================================================================================
================================================================================================================================ GLOBAL STRATEGY Employee retirement REALIGNMENT (D) and severance Asset Asset Other (millions) benefits(a) write-offs removal costs (c) Total -------------------------------------------------------------------------------------------------------------------------------- 2000 restructuring charges $ 25.7 $ 29.9 $ 7.3 $ 2.3 $ 65.2 Amounts utilized during 2000 (5.9) (29.9) (1.6) (2.3) (39.7) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2000 $ 19.8 $ -- $ 5.7 $ -- $ 25.5 2001 restructuring charges, net of credits 6.9 28.6 1.0 (.2) 36.3 Amounts utilized during 2001 (20.6) (28.6) (5.1) .2 (54.1) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2001 $ 6.1 $ -- $ 1.6 $ -- $ 7.7 Amounts utilized during 2002 (4.7) -- (1.6) -- (6.3) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 28, 2002 $ 1.4 $ -- $ -- $ -- $ 1.4 ================================================================================================================================
================================================================================================================================ CONSOLIDATED Employee retirement and severance Asset Asset Other (millions) benefits(a) write-offs removal costs (c) Total -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 1999 $ 31.4 $ -- $ 28.5 $ -- $ 59.9 2000 restructuring charges 45.3 29.9 7.3 4.0 86.5 Amounts utilized during 2000 (53.4) (29.9) (18.9) (4.0) (106.2) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2000 $ 23.3 $ -- $ 16.9 $ -- $ 40.2 2001 restructuring charges, net of credits 5.8 27.5 .2 (.2) 33.3 Amounts utilized during 2001 (22.7) (27.5) (13.6) 0.2 (63.6) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 31, 2001 $ 6.4 $ -- $ 3.5 $ -- $ 9.9 Amounts utilized during 2002 (5.0) -- (3.5) -- (8.5) -------------------------------------------------------------------------------------------------------------------------------- Remaining reserve at December 28, 2002 $ 1.4 $ -- $ -- $ -- $ 1.4 ================================================================================================================================
(a) Includes net (gains) or losses from pension and postretirement health care curtailment and special termination benefits as follows (refer to Notes 9 and 10):
======================================================== 2001 2000 -------------------------------------------------------- Pan-European reorganization $ -- $ 5 Global strategy realignment (2) 3 -------------------------------------------------------- Consolidated ($ 2) $ 8 ========================================================
(b) Negative removal reserves in Europe result from netting of anticipated proceeds from asset sales with removal costs. (c) Consist primarily of program-related non-exit costs incurred during the period of the reported charge. (d) Includes initiatives related to preparing Kellogg for the Keebler integration. NOTE 4 OTHER INCOME (EXPENSE), NET Other income (expense), net includes non-operating items such as interest income, foreign exchange gains and losses, charitable donations, and gains on asset sales. Other income (expense), net for 2002 consists primarily of a $24.7 million credit related to legal settlements. Other income (expense), net for 2000 includes a credit of approximately $12 million related to the 1999 sale of the Lender's Bagels business to Aurora Foods Inc. The total amount consists of approximately $9 million for disposal of assets associated with the business which were not purchased by Aurora and approximately $3 million for final working capital settlement with Aurora. NOTE 5 EQUITY EARNINGS PER SHARE Basic net earnings per share is determined by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted net earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Kellogg Company 37 Dilutive potential common shares are comprised principally of employee stock options issued by the Company. Basic net earnings per share is reconciled to diluted net earnings per share as follows:
================================================================================================================ Earnings before extraordinary loss and cumulative effect of accounting change ------------------------------------------------------------- Average shares (millions, except per share data) Earnings outstanding Per share ---------------------------------------------------------------------------------------------------------------- 2002 Basic $ 720.9 408.4 $ 1.77 Dilutive employee stock options -- 3.1 (.02) ---------------------------------------------------------------------------------------------------------------- Diluted $ 720.9 411.5 $ 1.75 ================================================================================================================ 2001 Basic $ 482.0 406.1 $ 1.19 Dilutive employee stock options -- 1.1 (.01) ---------------------------------------------------------------------------------------------------------------- Diluted $ 482.0 407.2 $ 1.18 ================================================================================================================ 2000 Basic $ 587.7 405.6 $ 1.45 Dilutive employee stock options -- .2 -- ---------------------------------------------------------------------------------------------------------------- Diluted $ 587.7 405.8 $ 1.45 ================================================================================================================
COMPREHENSIVE INCOME Comprehensive income includes all changes in equity during a period except those resulting from investments by or distributions to shareholders. Comprehensive income for the periods presented consists of net earnings, minimum pension liability adjustments (refer to Note 9), unrealized gains and losses on cash flow hedges pursuant to SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities", and foreign currency translation adjustments pursuant to SFAS No. 52 "Foreign Currency Translation" as follows:
===================================================================================================================== Tax Pretax (expense) After-tax (millions) amount benefit amount --------------------------------------------------------------------------------------------------------------------- 2002 Net earnings $ 720.9 Other comprehensive income: Foreign currency translation adjustments $ 1.6 $ -- 1.6 Cash flow hedges: Unrealized gain (loss) on cash flow hedges (2.9) 1.3 (1.6) Reclassification to net earnings 6.9 (2.7) 4.2 Minimum pension liability adjustments (453.5) 147.3 (306.2) --------------------------------------------------------------------------------------------------------------------- ($ 447.9) $ 145.9 (302.0) --------------------------------------------------------------------------------------------------------------------- Total comprehensive income $ 418.9 =====================================================================================================================
===================================================================================================================== Tax Pretax (expense) After-tax (millions) amount benefit amount --------------------------------------------------------------------------------------------------------------------- 2001 Net earnings $ 473.6 Other comprehensive income: Foreign currency translation adjustments ($ 60.4) $ -- (60.4) Cash flow hedges: Unrealized gain (loss) on cash flow hedges (86.3) 31.9 (54.4) Reclassification to net earnings 8.8 (3.3) 5.5 Minimum pension liability adjustments (9.8) 3.0 (6.8) --------------------------------------------------------------------------------------------------------------------- ($ 147.7) $ 31.6 (116.1) --------------------------------------------------------------------------------------------------------------------- Total comprehensive income $ 357.5 =====================================================================================================================
===================================================================================================================== Tax Pretax (expense) After-tax (millions) amount benefit amount --------------------------------------------------------------------------------------------------------------------- 2000 Net earnings $ 587.7 Other comprehensive income: Foreign currency translation adjustments ($ 97.4) $ -- (97.4) Minimum pension liability adjustments (10.0) 3.5 (6.5) --------------------------------------------------------------------------------------------------------------------- ($107.4) $ 3.5 (103.9) --------------------------------------------------------------------------------------------------------------------- Total comprehensive income $ 483.8 =====================================================================================================================
Accumulated other comprehensive income (loss) at year-end consisted of the following:
============================================================================================================= (millions) 2002 2001 ------------------------------------------------------------------------------------------------------------- Foreign currency translation adjustments ($ 487.6) ($ 489.2) Cash flow hedges - unrealized net loss (46.3) (48.9) Minimum pension liability adjustments (319.5) (13.3) ------------------------------------------------------------------------------------------------------------- Total accumulated other comprehensive income (loss) ($ 853.4) ($ 551.4) =============================================================================================================
NOTE 6 LEASES AND OTHER COMMITMENTS The Company's leases are generally for equipment and warehouse space. Rent expense on all operating leases was $89.5 million in 2002, $100.0 million in 2001, and $36.7 million in 2000. The increase in 2001 rent expense as compared to 2000 relates primarily to operating leases held by Keebler Foods Company, acquired by the Company in March 2001 (refer to Note 2 for further information). Additionally, the Company is subject to residual value guarantees and secondary liabilities on operating leases totaling approximately $14 million, for which liabilities of $.6 million had been recorded at December 28, 2002. 38 Kellogg Company At December 28, 2002, future minimum annual lease commitments under noncancelable capital and operating leases were as follows:
================================================================================ Operating Capital (millions) leases leases -------------------------------------------------------------------------------- 2003 $ 92.0 $ 1.5 2004 52.7 2.0 2005 41.6 1.3 2006 32.7 1.3 2007 29.3 .9 2008 and beyond 53.3 -- -------------------------------------------------------------------------------- Total minimum payments $ 301.6 $ 7.0 Amount representing interest (1.0) -------------------------------------------------------------------------------- Obligations under capital leases 6.0 Obligations due within one year 1.2 -------------------------------------------------------------------------------- Long-term obligations under capital leases $ 4.8 ================================================================================
The Company's Keebler subsidiary is guarantor on loans to independent contractors for the purchase of DSD route franchises. At year-end 2002, there were total loans outstanding of $14.1 million to 526 franchisees. All loans are variable rate with a term of 10 years. Related to this arrangement, the Company has established a five-year renewable loan facility and servicing arrangement up to $15.0 million with a financial institution. The Company has the right to revoke and resell the route franchises in the event of default or any other breach of contract by franchisees. Revocations have been infrequent. The Company's maximum potential future payments under these guarantees are limited to the outstanding loan principal balance plus unpaid interest. At December 28, 2002, the Company had not recorded any liability related to this arrangement. In accordance with FASB Interpretation No. 45 (refer to Note 1), the Company will recognize the fair value of guarantees associated with new loans to DSD route franchisees issued beginning in 2003. These amounts are expected to be insignificant. The Company has provided various standard indemnifications in agreements to sell business assets and lease facilities over the past several years, related primarily to pre-existing tax, environmental, and employee benefit obligations. Certain of these indemnifications are limited by agreement in either amount and/or term and others are unlimited. Because the Company is not currently aware of any actual exposures associated with these indemnifications, management is unable to estimate the maximum potential future payments to be made. At December 28, 2002, the Company had not recorded any liability related to these indemnifications. NOTE 7 DEBT Notes payable at year-end consisted of commercial paper borrowings in the United States and, to a lesser extent, bank loans of foreign subsidiaries at competitive market rates, as follows:
=================================================================================== (dollars in millions) 2002 2001 ----------------------------------------------------------------------------------- EFFECTIVE Effective PRINCIPAL INTEREST Principal interest AMOUNT RATE amount rate ---------------------------------------------------------------------------------- U.S. commercial paper $ 409.8 2.0% $ 320.8 3.0% Canadian commercial paper -- -- 171.1 2.5% Other 11.1 21.4 ---------------------------------------------------------------------------------- $ 420.9 $ 513.3 ===================================================================================
Long-term debt at year-end consisted primarily of fixed rate issuances of U.S. and Euro Dollar Notes, as follows:
================================================================================ (millions) 2002 2001 -------------------------------------------------------------------------------- (a) 4.875% U.S. Dollar Notes due 2005 $ 200.0 $ 200.0 (b) 6.625% Euro Dollar Notes due 2004 500.0 500.0 (c) 5.5% U.S. Dollar Notes due 2003 699.1 998.4 (c) 6.0% U.S. Dollar Notes due 2006 995.8 994.5 (c) 6.6% U.S. Dollar Notes due 2011 1,492.7 1,491.8 (c) 7.45% U.S. Dollar Debentures due 2031 1,085.8 1,085.3 (d) 4.49% U.S. Dollar Notes due 2006 300.0 375.0 Other 22.4 56.3 -------------------------------------------------------------------------------- 5,295.8 5,701.3 Less current maturities (776.4) (82.3) -------------------------------------------------------------------------------- Balance at year end $4,519.4 $5,619.0 ================================================================================
(a) In October 1998, the Company issued $200 of seven-year 4.875% fixed rate U.S. Dollar Notes to replace maturing long-term debt. In conjunction with this issuance, the Company settled $200 notional amount of interest rate forward swap agreements, which, when combined with original issue discount, effectively fixed the interest rate on the debt at 6.07%. (b) In January 1997, the Company issued $500 of seven-year 6.625% fixed rate Euro Dollar Notes. In conjunction with this issuance, the Company settled $500 notional amount of interest rate forward swap agreements, which effectively fixed the interest rate on the debt at 6.354%. (c) In March 2001, the Company issued $4,600 of long-term debt instruments, further described in the table below, primarily to finance the acquisition of Keebler Foods Company (refer to Note 2). Initially, these instruments were privately placed, or sold outside the United States, in reliance on exemptions from registration under the Securities Act of 1933, as amended (the "1933 Act"). The Company then exchanged new debt securities for these initial debt instruments, with the new debt securities being substantially identical in all respects to the initial debt instruments, except for being registered under the 1933 Act. These debt securities contain standard events of default and covenants. The Notes due 2006 and 2011, and the Debentures due 2031 may be redeemed in whole or part by the Company at any time at prices determined under a formula (but not less than 100% of the principal amount plus unpaid interest to the redemption date). In conjunction with this issuance, the Company settled $1,900 notional amount of forward-starting interest rate swaps for approximately $88 in cash. The swaps effectively fixed a portion of the interest rate on an equivalent amount of debt prior to issuance. The swaps were designated as cash flow hedges pursuant to SFAS No. 133 (refer to Note 12). As a result, the loss on settlement (net of tax benefit) of $56 was recorded in other comprehensive income, and is being amortized to interest expense over periods of 5 to 30 years. The pretax loss of $88 is presented in the "Other" caption within the Consolidated Statement of Cash Flows for 2001. The effective interest rates presented in the following table reflect this amortization expense, as well as discount on the debt.
============================================================================================= Principal Effective (dollars in millions) amount Net proceeds interest rate --------------------------------------------------------------------------------------------- 5.5% U.S. Dollar Notes due 2003 $1,000.0 $ 997.4 5.64% 6.0% U.S. Dollar Notes due 2006 1,000.0 993.5 6.39% 6.6% U.S. Dollar Notes due 2011 1,500.0 1,491.2 7.08% 7.45% U.S. Dollar Debentures due 2031 1,100.0 1,084.9 7.62% --------------------------------------------------------------------------------------------- $4,600.0 $4,567.0 =============================================================================================
In September 2002, the Company redeemed $300.7 of the Notes due 2003 and a subsidiary of the Company issued $400 of U.S. commercial paper. (d) In November 2001, a subsidiary of the Company issued $375 of five-year 4.49% fixed rate U.S. Dollar Notes to replace other maturing debt. These Notes are guaranteed by the Company and mature $75 per year over the five-year term. These Notes, which were privately placed, contain standard warranties, events of default, and covenants. They also require the maintenance of a specified consolidated interest expense coverage ratio, and limit capital lease obligations and subsidiary debt. In conjunction with this issuance, the subsidiary of the Company entered into a $375 notional US$/ Pound Sterling currency swap, which effectively converted this debt into a 5.302% fixed rate Pound Sterling obligation for the duration of the five-year term. During 2001, the Company entered into a 364-Day Credit Agreement, which was renewed in January 2002 and 2003, and a Five-Year Credit Agreement, expiring in January 2006. The current 364-day agreement permits the Company or certain subsidiaries to borrow up to $850 million. The five-year agreement permits the Company or certain subsidiaries to borrow up to $1.15 billion (or certain amounts in foreign currencies). These two credit agreements contain standard warranties, events of default, and covenants. They also require the maintenance of a specified amount of consolidated net worth and a specified consolidated interest expense coverage ratio, and limit capital lease obligations and subsidiary debt. These credit facilities were unused at December 28, 2002. At December 28, 2002, the Company had $2.2 billion of short-term lines of credit, virtually all of which were unused and available for borrowing on an unsecured basis. Kellogg Company 39 At December 28, 2002, the Company had entered into forward interest rate contracts to fix the Treasury component of the coupon rate on $200 million notional amount of long-term debt expected to be issued in 2003, as a replacement for other maturing debt. Scheduled principal repayments on long-term debt are (in millions): 2003-$776.4; 2004-$583.3; 2005-$279.6; 2006-$1,077.3; 2007-$2.4; 2008 and beyond-$2,603.8. Interest paid was (in millions): 2002-$386; 2001-$303; 2000-$141. Interest expense capitalized as part of the construction cost of fixed assets was (in millions): 2002-$1.0; 2001-$2.9; 2000-$5.6. NOTE 8 STOCK COMPENSATION The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives are administered through several plans, as described below. The 2002 Employee Stock Purchase Plan (the "Plan") was approved by shareholders in 2002 and permits eligible employees to purchase Company stock at a discounted price. The Plan allows for a maximum of 2,500,000 shares of Company stock to be issued at a purchase price equal to the lesser of 85% of the fair market value of the stock on the first or last day of the quarterly purchase period. Total purchases through the Plan for any employee are limited to a fair market value of $25,000 during any calendar year. Under this plan, approximately 119,000 shares were purchased during 2002. Additionally, a subsidiary of the Company maintains a stock purchase plan for its employees. Subject to limitations, employee contributions to this plan are matched 1:1 by the Company. Under this plan, approximately 82,000 shares were granted by the Company during 2002 to match an approximately equal number of shares purchased by employees. The Executive Stock Purchase Plan was established in 2002 to encourage and enable certain eligible employees of the Company to acquire Company stock, and to align more closely the interests of those individuals and the Company's shareholders. This plan allows for a maximum of 500,000 shares of Company stock to be issued. Under this plan, approximately 14,000 shares were granted to executives during 2002 in lieu of cash bonuses. The 2001 Long-Term Incentive Plan ("2001 Plan") provides for benefits to be awarded to key employees and officers in the form of incentive and non-qualified stock options, performance shares, performance units, restricted stock grants, and other stock-based awards. The 2001 Plan was approved by shareholders in 2000 and authorizes the issuance of up to 26 million shares, with no more than 2.75 million shares to be issued in satisfaction of performance units, performance-based restricted shares and other awards (excluding stock options and stock appreciation rights). Options granted under this plan generally vest over two years, subject to earlier vesting if a change of control occurs. Restricted stock grants under this plan generally vest in three years. Under this plan, the Company made restricted stock grants to eligible employees of approximately 132,000 shares in 2002 and approximately 300,000 shares in 2001. Also under this plan, performance units were awarded during 2002 to a limited number of senior executive-level employees for the achievement of cumulative cash flow targets for a three-year period through year-end 2003 and net sales growth targets for a three-year period through year-end 2004. If the performance targets are met, the award of units represents the right to receive shares of common stock equal to the dollar award valued on the vesting date. The awards are earned and vest in February 2004 and February 2005. No awards are earned unless a minimum threshold is attained. The maximum dollar award that could be attained under the programs is $25 million. The 2001 Plan and the Non-Employee Director Stock Plan described below contain an accelerated ownership feature ("AOF"). An AOF option is generally granted when Company stock is used to pay the exercise price of a stock option or any taxes owed. The holder of the option is generally granted an AOF option for the number of shares so used with the exercise price equal to the then fair market value of the Company's stock. For all AOF options, the original expiration date is not changed but the options vest immediately. Prior to approval by shareholders during 2000 of the 2001 Plan, the Key Employee Long-Term Incentive Plan provided substantially similar stock-based benefits to executive-level employees. Under this plan, approximately 100,000 restricted shares of common stock were granted during 2000 to eligible employees. The Kellogg Employee Stock Ownership Plan was designed to offer stock and other incentive awards based on Company performance to employees who were not eligible to participate in the Key Employee Long Term Incentive Plan. Options which have been awarded under this plan generally vest over five years. Options under all plans described above are granted with exercise prices equal to the fair market value of the Company's common stock at the time of the grant and have a term of no more than 10 years, if they are incentive stock options, or no more than 10 years and one day, if they are non-qualified stock options. The Non-Employee Director Stock Plan was approved by shareholders in 2000 and allows each eligible non-employee director to receive 1,700 shares of the Company's common stock annually and annual grants of options to purchase 5,000 shares of the Company's common stock. Shares other than options are placed in the Kellogg Company Grantor Trust for Non-Employee Directors (the "Grantor Trust"). Under the terms of the Grantor Trust, shares are available to a director only upon termination of service on the Board. During 2002, 50,850 options and 18,700 shares of common stock were granted under this plan. During 2001, 55,000 options and 17,000 shares were granted. As permitted by SFAS No. 123 "Accounting for Stock-Based Compensation," the Company has elected to account for employee and director stock option grants under APB No. 25 "Accounting for Stock Issued to Employees." Accordingly, no compensation cost has been recognized for these grants. 40 Kellogg Company 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 No. 123, the Company's reported results are reconciled to pro forma results as follows:
================================================================================ (millions, except per share data) 2002 2001 2000 -------------------------------------------------------------------------------- Stock-based compensation expense, net of tax: As reported $ 10.7 $ 5.4 $ 2.5 Pro forma $ 52.8 $ 29.1 $ 23.1 Net earnings: As reported $720.9 $473.6 $587.7 Pro forma $678.8 $449.9 $567.1 Basic net earnings per share: As reported $ 1.77 $ 1.17 $ 1.45 Pro forma $ 1.66 $ 1.11 $ 1.40 Diluted net earnings per share: As reported $ 1.75 $ 1.16 $ 1.45 Pro forma $ 1.65 $ 1.10 $ 1.40 ================================================================================
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:
======================================================================= 2002 2001 2000 ----------------------------------------------------------------------- Risk-free interest rate 3.58% 4.57% 6.59% Dividend yield 2.92% 3.30% 3.90% Volatility 29.71% 28.21% 25.43% Average expected term (years) 3.00 3.08 3.17 Fair value of options granted $ 6.67 $ 5.05 $ 4.60 =======================================================================
Transactions under these plans were:
============================================================================================================= (millions) 2002 2001 2000 ------------------------------------------------------------------------------------------------------------- Under option, beginning of year 37.0 23.4 19.9 Granted 9.2 17.1 6.4 Exercised (5.2) (1.3) (.1) Cancelled (2.8) (2.2) (2.8) ------------------------------------------------------------------------------------------------------------- Under option, end of year 38.2 37.0 23.4 ------------------------------------------------------------------------------------------------------------- Exercisable, end of year 20.1 16.9 13.7 ============================================================================================================= Shares available, end of year, for stock-based awards that may be granted under the following plans: Key Employee Long-Term Incentive Plan -- -- 3.2 Kellogg Employee Stock Ownership Plan .6 2.8 4.8 2000 Non-Employee Director Stock Plan .6 .9 .9 2001 Long-Term Incentive Plan (a) 10.1 16.1 26.0 2002 Employee Stock Purchase Plan 2.4 -- -- Executive Stock Purchase Plan .5 -- -- ------------------------------------------------------------------------------------------------------------- Total shares available, end of year, for stock-based awards that may be granted 14.2 19.8 34.9 =============================================================================================================
(a) All shares are available for stock options and stock appreciation rights with no more than 2.0 million shares remaining to be issued in satisfaction of performance units, performance-based restricted shares, and other awards.
========================================================================= Average prices per share 2002 2001 2000 ------------------------------------------------------------------------- Under option, beginning of year $ 31 $ 34 $ 38 Granted 33 27 24 Exercised 27 25 26 Cancelled 32 34 36 ------------------------------------------------------------------------- Under option, end of year $ 33 $ 31 $ 34 ------------------------------------------------------------------------- Exercisable, end of year $ 34 $ 36 $ 38 =========================================================================
Employee stock options outstanding and exercisable under these plans as of December 28, 2002, were:
============================================================================ (millions, except per share data) Outstanding Exercisable ------------------------------------- --------------------------- Weighted Weighted average Weighted Range of average remaining average exercise Number exercise contractual Number exercise prices of options price life (yrs.) of options price ------------------------------------------------ -------------------------- $ 19 - 26 8.3 $ 26 7.9 3.8 $ 25 27 - 28 7.6 28 8.1 3.2 28 29 - 36 13.5 34 8.4 5.1 34 37 - 50 8.8 42 5.0 8.0 42 ------------------------------------------------ -------------------------- 38.2 20.1 ================================================ ===========================
NOTE 9 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 2.0% and 1.7% of consolidated plan assets at December 28, 2002, and December 31, 2001, respectively. The components of pension expense were:
=================================================================================== (millions) 2002 2001 2000 ----------------------------------------------------------------------------------- Service cost $ 57.0 $ 47.4 $ 34.5 Interest cost 140.7 124.5 91.1 Expected return on plan assets (217.5) (192.4) (143.3) Amortization of unrecognized transition obligation .3 .3 .6 Amortization of unrecognized prior service cost 6.9 6.6 7.0 Recognized net (gain) loss 11.5 4.6 (4.2) Curtailment and special benefits - net (gain) loss -- (1.5) 8.5 ----------------------------------------------------------------------------------- Pension income - Company plans (1.1) (10.5) (5.8) Pension expense - defined contribution plans 2.9 3.0 2.2 ----------------------------------------------------------------------------------- Total pension expense (income) $ 1.8 ($ 7.5) ($ 3.6) ===================================================================================
The worldwide weighted average actuarial assumptions at year-end were:
================================================================================== 2002 2001 2000 ---------------------------------------------------------------------------------- Discount rate 6.6% 7.0% 7.0% Long-term rate of compensation increase 4.7% 4.7% 4.6% Long-term rate of return on plan assets 9.3% 10.5% 10.4% ==================================================================================
Kellogg Company 41 The aggregate change in projected benefit obligation, change in plan assets, and funded status were:
=========================================================================================================== (millions) 2002 2001 ----------------------------------------------------------------------------------------------------------- CHANGE IN PROJECTED BENEFIT OBLIGATION Projected benefit obligation at beginning of year $ 2,038.7 $ 1,381.5 Acquisition adjustment (13.4) 613.4 Service cost 57.0 47.4 Interest cost 140.7 124.5 Plan participants' contributions 1.2 1.3 Amendments 28.3 .7 Actuarial loss 97.8 9.7 Benefits paid (137.2) (123.4) Foreign currency adjustments 46.2 (17.1) Other 2.1 .7 ----------------------------------------------------------------------------------------------------------- Projected benefit obligation at end of year $ 2,261.4 $ 2,038.7 =========================================================================================================== CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ 1,845.3 $ 1,405.0 Acquisition adjustment (21.4) 568.6 Actual return on plan assets (191.3) (13.8) Employer contributions 309.3 23.8 Plan participants' contributions 1.2 1.3 Benefits paid (133.7) (121.6) Foreign currency adjustments 39.9 (18.2) Other .2 .2 ----------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year $ 1,849.5 $ 1,845.3 =========================================================================================================== FUNDED STATUS ($ 411.9) ($ 193.4) Unrecognized net loss 846.7 334.0 Unrecognized transition amount 2.3 2.4 Unrecognized prior service cost 51.8 29.5 ----------------------------------------------------------------------------------------------------------- Prepaid pension $ 488.9 $ 172.5 =========================================================================================================== AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET CONSIST OF Prepaid benefit cost $ 364.2 $ 287.4 Accrued benefit liability (376.1) (140.3) Intangible asset 27.5 5.6 Minimum pension liability 473.3 19.8 ----------------------------------------------------------------------------------------------------------- Net amount recognized $ 488.9 $ 172.5 ===========================================================================================================
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were:
===================================================================== (millions) 2002 2001 --------------------------------------------------------------------- Projected benefit obligation $ 1,779.4 $ 204.1 Accumulated benefit obligation 1,569.1 178.9 Fair value of plan assets 1,340.6 68.9 =====================================================================
All gains and losses, other than those related to curtailment or special termination benefits, are recognized over the average remaining service period of active plan participants. Net gains or losses from curtailment and special termination benefits recognized in 2001 and 2000 were recorded as a component of restructuring charges. Refer to Note 3 for further information. At December 28, 2002, a cumulative after-tax charge of $319.5 million ($473.3 million pretax) was recorded in other comprehensive income to recognize the additional minimum pension liability in excess of unrecognized prior service cost. Certain of the Company's subsidiaries sponsor 401(k) or similar savings plans for active employees. Expense related to these plans was (in millions): 2002-$26; 2001-$25; 2000-$16. NOTE 10 NONPENSION POSTRETIREMENT BENEFITS Certain of the Company's U.S. and Canadian employees are currently eligible to participate in benefit plans which cover a portion of their life insurance and retiree health care costs. Benefits for union employees are contractually bargained. Eligibility for qualified employees is generally based on attainment of certain age and service requirements. Plan assets consist primarily of equity securities with smaller holdings of bonds, real estate, and other investments. Components of postretirement benefit expense were:
=============================================================================================================== (millions) 2002 2001 2000 --------------------------------------------------------------------------------------------------------------- Service cost $ 11.9 $ 10.7 $ 7.7 Interest cost 60.3 49.7 44.4 Expected return on plan assets (26.8) (24.5) (21.4) Amortization of unrecognized prior service cost (2.3) (1.1) (1.1) Recognized net (gains) losses 9.2 (2.3) (3.2) Curtailment and special termination benefits - net gain (16.9) (.2) (.1) --------------------------------------------------------------------------------------------------------------- Postretirement benefit expense $ 35.4 $ 32.3 $ 26.3 ===============================================================================================================
The weighted average actuarial assumptions at year-end were:
================================================================================ 2002 2001 2000 -------------------------------------------------------------------------------- Discount rate 6.90% 7.25% 7.50% Long-term rate of return on plan assets 9.3% 10.5% 10.5% ================================================================================
The aggregate change in accumulated postretirement benefit obligation, change in plan assets, and funded status were:
============================================================================================================ (millions) 2002 2001 ------------------------------------------------------------------------------------------------------------ CHANGE IN ACCUMULATED BENEFIT OBLIGATION Accumulated benefit obligation at beginning of year $ 895.2 $ 618.6 Acquisition adjustment (2.2) 92.9 Service cost 11.9 10.7 Interest cost 60.3 49.7 Actuarial loss 90.2 171.8 Amendments (97.3) .2 Benefits paid (50.4) (48.3) Other .9 (.4) ------------------------------------------------------------------------------------------------------------ Accumulated benefit obligation at end of year $ 908.6 $ 895.2 ============================================================================================================ CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ 212.6 $ 222.9 Actual return on plan assets (27.5) (16.4) Employer contributions 137.3 52.5 Benefits paid (42.5) (46.9) Other .5 .5 ------------------------------------------------------------------------------------------------------------ Fair value of plan assets at end of year $ 280.4 $ 212.6 ============================================================================================================ FUNDED STATUS ($ 628.2) ($ 682.6) Unrecognized net loss 265.6 188.4 Unrecognized prior service cost (28.7) (8.3) ------------------------------------------------------------------------------------------------------------ Accrued postretirement benefit cost ($ 391.3) ($ 502.5) ============================================================================================================ AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET CONSIST OF Accrued benefit liability ($ 391.3) ($ 502.5) ============================================================================================================
The assumed health care cost trend rate is 8% for 2003, decreasing gradually to 5% by the year 2006 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: 42 Kellogg Company
===================================================================================================== One percentage One percentage (millions) point increase point decrease ---------------------------------------------------------------------------------------------------- Effect on total of service and interest cost components $ 9.5 $ 7.7 Effect on postretirement benefit obligation $102.2 $ 82.8 =====================================================================================================
All gains and losses, other than those related to curtailment or special termination benefits, are recognized over the average remaining service period of active plan participants. Net gains from curtailment and special termination benefits recognized in 2001 and 2000 were recorded as a component of restructuring charges. Refer to Note 3 for further information. During 2002, the Company recognized a $16.9 million curtailment gain related to a change in certain retiree health care benefits from employer-provided defined benefit plans to multi-employer defined contribution plans. The Company contributes to a voluntary employee benefit association (VEBA) trust for funding of certain of its nonpension postretirement benefit obligations. NOTE 11 INCOME TAXES Earnings before income taxes, extraordinary loss, and cumulative effect of accounting change, and the provision for U.S. federal, state, and foreign taxes on these earnings, were:
=============================================================================================== (millions) 2002 2001 2000 ----------------------------------------------------------------------------------------------- EARNINGS BEFORE INCOME TAXES, EXTRAORDINARY LOSS, AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE United States $ 791.3 $ 464.2 $ 561.9 Foreign 353.0 339.9 305.8 ----------------------------------------------------------------------------------------------- $ 1,144.3 $ 804.1 $ 867.7 ----------------------------------------------------------------------------------------------- INCOME TAXES Currently payable Federal $ 157.1 $ 120.9 $ 134.0 State 46.2 30.1 20.3 Foreign 108.9 99.6 127.1 ----------------------------------------------------------------------------------------------- 312.2 250.6 281.4 ----------------------------------------------------------------------------------------------- Deferred Federal 82.8 53.1 (1.2) State 8.4 1.2 4.1 Foreign 20.0 17.2 (4.3) ----------------------------------------------------------------------------------------------- 111.2 71.5 (1.4) ----------------------------------------------------------------------------------------------- Total income taxes $ 423.4 $ 322.1 $ 280.0 ===============================================================================================
The difference between the U.S. federal statutory tax rate and the Company's effective rate was:
======================================================================================== 2002 2001 2000 ---------------------------------------------------------------------------------------- U.S. statutory rate 35.0% 35.0% 35.0% Foreign rates varying from 35% -.8 -1.1 -.6 State income taxes, net of federal benefit 3.1 2.5 1.8 Foreign earnings repatriation 2.8 -- -- Donation of appreciated assets -1.5 -- -- Net change in valuation allowances -.2 .1 -3.0 Non-deductible goodwill amortization -- 2.9 .6 Statutory rate changes, deferred tax impact -- -.1 -.3 Other -1.4 .8 -1.2 ---------------------------------------------------------------------------------------- Effective income tax rate 37.0% 40.1% 32.3% ========================================================================================
Generally, the changes in valuation allowances on deferred tax assets and corresponding impacts on the effective income tax rate, as presented above, result from management's assessment of the Company's ability to utilize certain operating loss and tax credit carry-forwards. For 2000, the change in valuation allowance relates primarily to utilization of U.S. foreign tax credit carryforwards. As a result, the effective income tax rate was significantly lower in 2000 as compared to either 2001 or 2002. For 2001, the significant increase in the income tax rate impact of non-deductible goodwill relates to the Company's acquisition of Keebler Foods Company (refer to Note 2). As a result of the Company's adoption of SFAS No. 142 on January 1, 2002 (refer to Note 1), goodwill amortization expense - and the resulting impact on the effective income tax rate - has been eliminated in post-2001 years. Total tax benefits of carryforwards at year-end 2002 and 2001 were $21.1 million and $23.9 million, respectively. Of the total carryforwards at year-end 2002, $4.8 million expire during 2003 and another $9.6 million expire within five years. Based on management's assessment of the Company's ability to utilize these benefits prior to expiration, the carrying value of deferred tax assets associated with carry-forwards was reduced by valuation allowances to approximately $6.4 million at December 28, 2002. The deferred tax assets and liabilities included in the balance sheet at year-end were:
=========================================================================================================================== Deferred tax assets Deferred tax liabilities (millions) 2002 2001 2002 2001 --------------------------------------------------------------------------------------------------------------------------- Current: Promotion and advertising $ 21.2 $ 16.3 $ 7.6 $ 7.2 Wages and payroll taxes 30.3 29.0 -- -- Inventory valuation 14.3 12.2 16.5 14.6 Health and postretirement benefits 53.9 28.9 .1 2.9 State taxes 17.2 11.7 -- -- Operating loss and credit carryforwards .2 .2 -- -- Deferred intercompany revenue 42.6 10.3 7.5 7.8 Keebler exit liabilities 6.7 23.3 -- -- Unrealized hedging losses, net 29.0 29.7 .1 .2 Other 31.1 28.3 5.7 3.0 --------------------------------------------------------------------------------------------------------------------------- 246.5 189.9 37.5 35.7 Less valuation allowance (2.6) (1.6) -- -- --------------------------------------------------------------------------------------------------------------------------- 243.9 188.3 37.5 35.7 =========================================================================================================================== Noncurrent: Depreciation and asset disposals 9.2 8.4 348.3 339.6 Health and postretirement benefits 282.3 185.7 187.2 71.1 Capitalized interest -- -- 17.2 21.2 State taxes -- -- 88.3 74.3 Operating loss and credit carryforwards 20.9 23.7 -- -- Trademarks and other intangibles -- -- 665.2 662.6 Deferred compensation 41.9 28.9 -- -- Other 21.8 36.2 10.5 16.2 --------------------------------------------------------------------------------------------------------------------------- 376.1 282.9 1,316.7 1,185.0 Less valuation allowance (32.1) (35.1) -- -- --------------------------------------------------------------------------------------------------------------------------- 344.0 247.8 1,316.7 1,185.0 --------------------------------------------------------------------------------------------------------------------------- Total deferred taxes $ 587.9 $ 436.1 $ 1,354.2 $ 1,220.7 ===========================================================================================================================
At December 28, 2002, foreign subsidiary earnings of approximately $857 million were considered permanently invested in those businesses. Accordingly, U.S. income taxes have not been provided on these earnings. Kellogg Company 43 Cash paid for income taxes was (in millions): 2002-$250; 2001-$196; 2000-$246. The 2001 amount is net of a tax refund of approximately $73 million related to the cash-out of Keebler employee and director stock options upon acquisition of Keebler Foods Company (refer to Note 2 for further information). NOTE 12 FINANCIAL INSTRUMENTS AND CREDIT RISK CONCENTRATION The fair values of the Company's financial instruments are based on carrying value in the case of short-term items, quoted market prices for derivatives and investments, and, in the case of long-term debt, incremental borrowing rates currently available on loans with similar terms and maturities. The carrying amounts of the Company's cash, cash equivalents, receivables, and notes payable approximate fair value. The fair value of the Company's long-term debt at December 28, 2002, exceeded its carrying value by approximately $565 million. The Company is exposed to certain market risks which exist as a part of its ongoing business operations and uses derivative financial and commodity instruments, where appropriate, to manage these risks. In general, instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the contract. In accordance with SFAS No. 133 (refer to Note 1), the Company designates derivatives as either cash flow hedges, fair value hedges, net investment hedges, or other contracts used to reduce volatility in the translation of foreign currency earnings to U.S. Dollars. The fair values of all hedges are recorded in accounts receivable or other current liabilities. Gains and losses representing either hedge ineffectiveness, hedge components excluded from the assessment of effectiveness, or hedges of translational exposure are recorded in other income (expense), net. These amounts were insignificant during 2002. CASH FLOW HEDGES Qualifying derivatives are accounted for as cash flow hedges when the hedged item is a forecasted transaction. Gains and losses on these instruments are recorded in other comprehensive income until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive income to the Statement of Earnings on the same line item as the underlying transaction. The total net loss attributable to cash flow hedges recorded in accumulated other comprehensive income at December 28, 2002, was $46.3 million, related primarily to forward-starting interest rate swaps settled during 2001 (refer to Note 7). This loss is being reclassified into interest expense over periods of 5 to 30 years. Other insignificant amounts related to foreign currency and commodity price cash flow hedges will be reclassified into earnings during the next 18 months. FAIR VALUE HEDGES Qualifying derivatives are accounted for as fair value hedges when the hedged item is a recognized asset, liability, or firm commitment. Gains and losses on these instruments are recorded in earnings, offsetting gains and losses on the hedged item. NET INVESTMENT HEDGES Qualifying derivative and non-derivative financial instruments are accounted for as net investment hedges when the hedged item is a foreign currency investment in a subsidiary. Gains and losses on these instruments are recorded as a foreign currency translation adjustment in other comprehensive income. OTHER CONTRACTS The Company also enters into foreign currency forward contracts and options to reduce volatility in the translation of foreign currency earnings to U.S. Dollars. Gains and losses on these instruments are recorded in other income (expense), net, generally reducing the exposure to translation volatility during a full-year period. FOREIGN EXCHANGE RISK The Company is exposed to fluctuations in foreign currency cash flows related primarily to third-party purchases, intercompany loans and product shipments, and non-functional currency denominated third-party debt. The Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, the Company is exposed to volatility in the translation of foreign currency earnings to U.S. Dollars. The Company assesses foreign currency risk based primarily on transactional cash flows and enters into forward contracts, options, and currency swaps to reduce fluctuations in net long or short currency positions. Forward contracts and options are generally less than 18 months duration. Currency swap agreements are established in conjunction with the term of underlying debt issues. For foreign currency cash flow and fair value hedges, the assessment of effectiveness is generally based on changes in spot rates. Changes in time value are reported in other income (expense), net. INTEREST RATE RISK The Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing issuances of variable rate debt. The Company currently uses interest rate swaps and forward interest rate contracts to reduce interest rate volatility and funding costs associated with certain debt issues, and to achieve a desired proportion of variable versus fixed rate debt, based on current and projected market conditions. Variable-to-fixed interest rate swaps are accounted for as cash flow hedges and the assessment of effectiveness is based on changes in the present value of interest payments on the underlying debt. Fixed-to-variable interest rate swaps are accounted for as fair value hedges and the assessment of effectiveness is based on changes in the fair value of the underlying debt, using incremental borrowing rates currently available on loans with similar terms and maturities. 44 Kellogg Company PRICE RISK The Company is exposed to price fluctuations primarily as a result of anticipated purchases of raw and packaging materials. The Company uses the combination of long cash positions with suppliers, and exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted purchases over a duration of generally less than 18 months. Commodity contracts are accounted for as cash flow hedges. The assessment of effectiveness is based on changes in futures prices. CREDIT RISK CONCENTRATION The Company is exposed to credit loss in the event of nonperformance by counterparties on derivative financial and commodity contracts. This credit loss is limited to the cost of replacing these contracts at current market rates. Management believes the probability of such loss is remote. Financial instruments, which potentially subject the Company to concentrations of credit risk, are primarily cash, cash equivalents, and accounts receivable. The Company places its investments in highly rated financial institutions and investment-grade short-term debt instruments, and limits the amount of credit exposure to any one entity. Historically, concentrations of credit risk with respect to accounts receivable have been limited due to the large number of customers, generally short payment terms, and their dispersion across geographic areas. However, there has been significant worldwide consolidation in the grocery industry in recent years. At December 28, 2002, the Company's five largest customers globally comprised approximately 20% of consolidated accounts receivable. NOTE 13 QUARTERLY FINANCIAL DATA (UNAUDITED) Historically, the Company has reported interim periods on a calendar-quarter basis. Certain business units within the Company have followed a thirteen week quarter convention, commonly referred to as "4-4-5" because of the number of weeks in each sub-period of the quarter. In order to facilitate conversion to SAP software and to achieve greater consistency and efficiency, all business units of the Company began reporting interim results on a "4-4-5" basis in 2002. Because prior-year results have not been restated, year-over-year comparability of quarterly results was significantly impacted, due principally to the change in reporting dates for the Keebler business. Keebler's 2001 interim results were reported for the periods ended March 24, June 16, October 6, and December 29; whereas, 2002 interim results were reported for the periods ended March 30, June 29, September 28, and December 28. However, the impact of this change on comparability of full-year results was insignificant.
================================================================================ (millions, except per share data) Net sales Gross profit 2002 2001 2002 2001 -------------------------------------------------------------------------------- First $ 2,061.8 $ 1,471.7 $ 884.6 $ 619.0 Second 2,125.1 1,989.2 963.6 867.0 Third 2,136.5 2,190.6 973.1 988.9 Fourth 1,980.7 1,896.9 913.8 862.1 -------------------------------------------------------------------------------- $ 8,304.1 $ 7,548.4 $ 3,735.1 $ 3,337.0 ================================================================================
========================================================================================= Earnings before extraordinary loss and Earnings per share before cumulative effect of extraordinary loss and cumulative accounting change effect of accounting change ----------------------------------------------------------------------------------------- 2002 2001 2002 2001 ----------------------------------------------------------------------------------------- Basic Diluted Basic Diluted ------------------------------------------------- First $ 152.6 $ 92.5 $ .37 $ .37 $ .23 $ .23 Second 173.8 114.6 .42 .42 .28 .28 Third 203.5 150.3 .50 .49 .37 .37 Fourth 191.0 124.6 .47 .47 .31 .31 ----------------------------------------------------------------------------------------- $ 720.9 $ 482.0 =========================================================================================
===================================================================================== Net earnings Net earnings per share ------------------------------------------------------------------------------------- 2002 2001 2002 2001 ------------------------------------------------------------------------------------- Basic Diluted Basic Diluted --------------------------------------------- First $ 152.6 $ 84.1 $ .37 $ .37 $ .21 $ .21 Second 173.8 114.6 .42 .42 .28 .28 Third 203.5 150.3 .50 .49 .37 .37 Fourth 191.0 124.6 .47 .47 .31 .31 ------------------------------------------------------------------------------------- $ 720.9 $ 473.6 =====================================================================================
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 2002, the closing price (on the NYSE) was $34.42 and there were 41,965 shareholders of record. Dividends paid per share and the quarterly price ranges on the NYSE during the last two years were:
====================================================================== Stock price Dividend ---------------------------- 2002 - QUARTER per share High Low ---------------------------------------------------------------------- First $ .2525 $ 34.95 $ 29.35 Second .2525 36.89 32.75 Third .2525 35.63 30.00 Fourth .2525 36.06 31.81 ---------------------------------------------------------------------- $1.0100 ====================================================================== 2001 - Quarter ---------------------------------------------------------------------- First $ .2525 $ 28.10 $ 25.00 Second .2525 29.00 25.18 Third .2525 33.56 28.61 Fourth .2525 31.70 28.90 ---------------------------------------------------------------------- $1.0100 ======================================================================
Kellogg Company 45 NOTE 14 OPERATING SEGMENTS Kellogg Company is the world's leading producer of ready-to-eat cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles, meat alternatives, pie crusts, and ice cream cones. Principal markets for these products include the United States and United Kingdom. The Company is managed in two major divisions - the United States and International - with International further delineated into Europe, Latin America, Canada, Australia, and Asia. Thus, the Company's reportable operating segments under SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" consist of the United States, Europe, and Latin America. All other geographic areas have been combined under the quantitative threshold guidelines of SFAS No. 131 for purposes of the information presented below. 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) 2002 2001 2000 -------------------------------------------------------------------------------------------------------- NET SALES (a) United States $ 5,525.4 $ 4,889.4 $ 3,263.6 Europe 1,469.8 1,360.7 1,462.2 Latin America 631.1 650.0 624.3 All other operating segments 677.8 648.3 716.1 Corporate -- -- 20.5 -------------------------------------------------------------------------------------------------------- Consolidated $ 8,304.1 $ 7,548.4 $ 6,086.7 ======================================================================================================== SEGMENT OPERATING PROFIT United States (e) $ 1,073.0 $ 875.5 $ 670.3 Europe 252.5 245.6 235.2 Latin America 170.1 171.1 161.7 All other operating segments 104.0 103.1 89.2 Corporate (e) (91.5) (90.5) (67.9) -------------------------------------------------------------------------------------------------------- Consolidated $ 1,508.1 $ 1,304.8 $ 1,088.5 Amortization eliminated by SFAS No. 142 (d) -- (103.6) (12.2) Restructuring charges (b) -- (33.3) (86.5) -------------------------------------------------------------------------------------------------------- Operating profit as reported $ 1,508.1 $ 1,167.9 $ 989.8 ======================================================================================================== RESTRUCTURING CHARGES (b) United States $ -- $ 29.5 $ 2.0 Europe -- (.2) 26.7 Latin America -- (.1) 14.6 All other operating segments -- 1.4 28.7 Corporate -- 2.7 14.5 -------------------------------------------------------------------------------------------------------- Consolidated $ -- $ 33.3 $ 86.5 ======================================================================================================== DEPRECIATION AND AMORTIZATION United States $ 219.7 $ 275.9 $ 131.4 Europe 65.7 59.5 57.1 Latin America 17.1 21.7 17.2 All other operating segments 30.0 31.4 40.8 Corporate 15.9 50.1 44.1 -------------------------------------------------------------------------------------------------------- Consolidated $ 348.4 $ 438.6 $ 290.6 ========================================================================================================
============================================================================================ (millions) 2002 2001 2000 -------------------------------------------------------------------------------------------- INTEREST EXPENSE United States $ 3.3 $ 5.7 $ -- Europe 22.3 2.9 4.7 Latin America .6 2.8 .1 All other operating segments 3.4 1.5 .4 Corporate 361.6 338.6 132.3 -------------------------------------------------------------------------------------------- Consolidated $ 391.2 $ 351.5 $ 137.5 ============================================================================================ INCOME TAXES EXCLUDING CHARGES (c) United States (e) $ 349.8 $ 235.5 $ 164.8 Europe 46.3 54.4 43.4 Latin America 42.5 40.3 40.0 All other operating segments 22.2 18.1 11.1 Corporate (e) (37.4) (13.4) 43.0 -------------------------------------------------------------------------------------------- Consolidated $ 423.4 $ 334.9 $ 302.3 Effect of charges -- (12.8) (22.3) -------------------------------------------------------------------------------------------- Income taxes as reported $ 423.4 $ 322.1 $ 280.0 ============================================================================================ TOTAL ASSETS United States $ 9,784.7 $ 9,634.4 $ 2,178.6 Europe 1,687.3 1,801.0 1,102.5 Latin America 337.4 415.5 444.6 All other operating segments 554.0 681.2 627.8 Corporate 6,112.1 5,697.6 2,061.2 Elimination entries (8,256.2) (7,861.1) (1,528.7) -------------------------------------------------------------------------------------------- Consolidated $ 10,219.3 $ 10,368.6 $ 4,886.0 ============================================================================================ ADDITIONS TO LONG-LIVED ASSETS United States $ 197.4 $ 5,601.2 $ 135.4 Europe 33.4 43.8 71.7 Latin America 13.6 11.7 39.7 All other operating segments 10.1 10.8 42.7 Corporate 1.2 29.5 138.1 -------------------------------------------------------------------------------------------- Consolidated $ 255.7 $ 5,697.0 $ 427.6 ============================================================================================
(a) 2001 and 2000 net sales restated for the retroactive application of EITF No. 01-09. Refer to Note 1 for further information. (b) Refer to Note 3 for further information on restructuring charges. (c) Charges include those described in (b) plus extraordinary loss and cumulative effect of accounting change in 2001, reported net of tax. Refer to Note 1 for further information. (d) 2001 and 2000 operating segment profitability has been restated to reflect the pro forma impact of SFAS No. 142. Refer to Note 1 for further information. (e) 2001 and 2000 U.S. operating segment profitability and income taxes have been restated for an internal reallocation of overhead between Corporate and U.S. operations. The Company's largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 12% of consolidated net sales during 2002 and 11% in 2001, comprised principally of sales within the United States. Sales to any single customer during 2000 were less than 10%. Supplemental geographic information is provided below for net sales to external customers and long-lived assets:
================================================================================= (millions) 2002 2001 2000 --------------------------------------------------------------------------------- NET SALES United States $ 5,525.4 $ 4,889.4 $ 3,263.6 United Kingdom 667.4 622.8 651.8 Other foreign countries 2,111.3 2,036.1 2,171.3 --------------------------------------------------------------------------------- Consolidated $ 8,304.1 $ 7,548.4 $ 6,086.7 ================================================================================= LONG-LIVED ASSETS United States $ 7,434.2 $ 7,275.9 $ 1,553.5 United Kingdom 423.5 526.6 535.4 Other foreign countries 584.6 651.5 1,154.0 --------------------------------------------------------------------------------- Consolidated $ 8,442.3 $ 8,454.0 $ 3,242.9 =================================================================================
46 Kellogg Company Supplemental product information is provided below for net sales to external customers:
================================================================================= (millions) 2002 2001 2000 --------------------------------------------------------------------------------- United States Retail channel cereal $ 1,952.1 $ 1,840.4 $ 1,806.3 Retail channel snacks 2,333.5 1,922.7 417.5 Other 1,239.8 1,126.3 1,039.8 International Cereal 2,476.9 2,381.5 2,530.5 Convenience foods 301.8 277.5 292.6 --------------------------------------------------------------------------------- Consolidated $ 8,304.1 $ 7,548.4 $ 6,086.7 =================================================================================
NOTE 15 SUPPLEMENTAL FINANCIAL STATEMENT DATA
(millions) ======================================================================================== CONSOLIDATED STATEMENT OF EARNINGS 2002 2001 2000 ---------------------------------------------------------------------------------------- Research and development expense $ 106.4 $ 110.2 $ 118.4 Advertising expense $ 588.7 $ 519.2 $ 604.2 ========================================================================================
============================================================================================ CONSOLIDATED STATEMENT OF CASH FLOWS 2002 2001 2000 -------------------------------------------------------------------------------------------- Accounts receivable $ 28.1 $ 100.9 $ 1.1 Inventories (26.4) 15.8 54.5 Other current assets 71.1 (17.8) (20.2) Accounts payable 41.3 47.6 75.1 Other current liabilities 151.2 112.9 (83.5) -------------------------------------------------------------------------------------------- CHANGES IN OPERATING ASSETS AND LIABILITIES $ 265.3 $ 259.4 $ 27.0 ============================================================================================ (millions) ================================================================================ CONSOLIDATED BALANCE SHEET 2002 2001 -------------------------------------------------------------------------------- Trade receivables $ 681.0 $ 692.0 Allowance for doubtful accounts (16.0) (15.5) Other receivables 76.0 85.8 -------------------------------------------------------------------------------- ACCOUNTS RECEIVABLE, NET $ 741.0 $ 762.3 -------------------------------------------------------------------------------- Raw materials and supplies $ 172.2 $ 170.7 Finished goods and materials in process 431.0 403.8 -------------------------------------------------------------------------------- INVENTORIES $ 603.2 $ 574.5 -------------------------------------------------------------------------------- Deferred income taxes $ 207.8 $ 151.5 Other prepaid assets 110.8 181.9 -------------------------------------------------------------------------------- OTHER CURRENT ASSETS $ 318.6 $ 333.4 -------------------------------------------------------------------------------- Land $ 62.6 $ 65.7 Buildings 1,345.6 1,279.1 Machinery and equipment 4,284.8 4,074.5 Construction in progress 159.6 192.7 Accumulated depreciation (3,012.4) (2,659.2) -------------------------------------------------------------------------------- PROPERTY, NET $ 2,840.2 $ 2,952.8 -------------------------------------------------------------------------------- Goodwill $ 3,106.6 $ 3,069.5 Other intangibles 2,046.6 2,070.2 -Accumulated amortization (20.6) (19.1) Other 483.1 393.2 -------------------------------------------------------------------------------- OTHER ASSETS $ 5,615.7 $ 5,513.8 -------------------------------------------------------------------------------- Accrued income taxes $ 151.7 $ 77.3 Accrued salaries and wages 228.0 233.5 Accrued advertising and promotion 309.0 233.2 Accrued interest 123.2 112.4 Other 386.7 378.1 -------------------------------------------------------------------------------- OTHER CURRENT LIABILITIES $ 1,198.6 $ 1,034.5 -------------------------------------------------------------------------------- Nonpension postretirement benefits $ 329.6 $ 475.1 Deferred income taxes 986.4 949.8 Other 473.8 245.6 -------------------------------------------------------------------------------- OTHER LIABILITIES $ 1,789.9 $ 1,670.5 ================================================================================
(millions) ================================================================================ INTANGIBLE ASSETS SUBJECT TO AMORTIZATION (A): -------------------------------------------------------------------------------- Gross carrying amount Accumulated amortization -------------------------------------------------------------------------------- 2002 2001 2002 2001 -------------------------------------------------------------------------------- Trademarks $ 29.5 $ 29.5 $ 17.2 $ 16.1 Other 6.7 6.6 3.4 3.0 -------------------------------------------------------------------------------- Total $ 36.2 $ 36.1 $ 20.6 $ 19.1 ================================================================================ -------------------------------------------------------------------------------- 2002 2001 -------------------------------------------------------------------------------- Amortization expense (b) $ 1.5 $ 6.6 ================================================================================
(a) Prior-year amounts presented in accordance with current-year classification under SFAS No. 142 - refer to Note 1 for further information. (b) The estimated aggregate amortization expense for each of the 5 succeeding fiscal years is approximately $1.5 per year.
================================================================================ INTANGIBLE ASSETS NOT SUBJECT TO AMORTIZATION (a): -------------------------------------------------------------------------------- Total carrying amount (b) -------------------------------------------------------------------------------- 2002 2001 -------------------------------------------------------------------------------- Trademarks $ 1,404.0 $ 1,404.0 Direct store door (DSD) delivery system 578.9 578.9 Other 27.5 51.2 -------------------------------------------------------------------------------- Total $ 2,010.4 $ 2,034.1 ================================================================================
(a) Prior-year amounts presented in accordance with current-year classification under SFAS No. 142 - refer to Note 1 for further information. (b) Total carrying amount is net of accumulated amortization through December 31, 2001.
================================================================================ CHANGES IN THE CARRYING AMOUNT OF GOODWILL (a): -------------------------------------------------------------------------------- Latin (millions) United States Europe America Other (c) Consolidated --------------------------------------------------------------------------------------------------------- January 1, 2001 $ 205.8 -- $ .8 $ 1.6 $ 208.2 Acquisition 2,919.8 -- -- .1 2,919.9 Amortization (60.6) -- -- (.1) (60.7) Foreign currency remeasurement impact and other -- -- 2.3 (.2) 2.1 --------------------------------------------------------------------------------------------------------- December 31, 2001 $ 3,065.0 -- $ 3.1 $ 1.4 $ 3,069.5 SFAS No. 142 reclassification (b) 46.3 -- -- -- 46.3 Purchase accounting adjustments 22.2 -- -- -- 22.2 Dispositions (30.3) (30.3) Foreign currency remeasurement impact and other -- -- (1.1) -- (1.1) --------------------------------------------------------------------------------------------------------- DECEMBER 28, 2002 $ 3,103.2 -- $ 2.0 $ 1.4 $ 3,106.6 =========================================================================================================
(a) Total carrying amount is net of accumulated amortization through December 31, 2001. (b) Assembled workforce intangible no longer meets separability criteria under SFAS No. 142 and has been reclassified to goodwill, effective January 1, 2002. (c) Other operating segments include Australia, Asia, and Canada. Kellogg Company 47 As discussed in Note 1, the Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets" on January 1, 2002. The provisions of SFAS No. 142 are adopted prospectively and prior-period financial statements are not restated. Comparative earnings information for prior periods is presented in the following tables:
================================================================================ EARNINGS BEFORE EXTRAORDINARY LOSS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE -------------------------------------------------------------------------------- Earnings (millions) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2002 2001 2000 -------------------------------------------------------------------------------- Originally reported $ 720.9 $ 482.0 $ 587.7 Goodwill amortization -- 59.0 5.7 Intangibles no longer amortized -- 26.0 3.9 -------------------------------------------------------------------------------- Total amortization $ -- $ 85.0 $ 9.6 -------------------------------------------------------------------------------- Comparable $ 720.9 $ 567.0 $ 597.3 ================================================================================ Per share - Basic -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2002 2001 2000 -------------------------------------------------------------------------------- Originally reported $ 1.77 $ 1.19 $ 1.45 Goodwill amortization -- .15 .01 Intangibles no longer amortized -- .06 .01 -------------------------------------------------------------------------------- Total amortization $ -- $ .21 $ .02 -------------------------------------------------------------------------------- Comparable $ 1.77 $ 1.40 $ 1.47 ================================================================================ Per share - Diluted -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2002 2001 2000 -------------------------------------------------------------------------------- Originally reported $ 1.75 $ 1.18 $ 1.45 Goodwill amortization -- .15 .01 Intangibles no longer amortized -- .06 .01 -------------------------------------------------------------------------------- Total amortization $ -- $ .21 $ .02 -------------------------------------------------------------------------------- Comparable $ 1.75 $ 1.39 $ 1.47 ================================================================================
================================================================================ NET EARNINGS -------------------------------------------------------------------------------- Earnings (millions) -------------------------------------------------------------------------------- 2002 2001 2000 -------------------------------------------------------------------------------- Originally reported $ 720.9 $ 473.6 $ 587.7 Goodwill amortization -- 59.0 5.7 Intangibles no longer amortized -- 26.0 3.9 -------------------------------------------------------------------------------- Total amortization $ -- $ 85.0 $ 9.6 -------------------------------------------------------------------------------- Comparable $ 720.9 $ 558.6 $ 597.3 ================================================================================ Per share - Basic -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2002 2001 2000 -------------------------------------------------------------------------------- Originally reported $ 1.77 $ 1.17 $ 1.45 Goodwill amortization -- .15 .01 Intangibles no longer amortized -- .06 .01 -------------------------------------------------------------------------------- Total amortization $ -- $ .21 $ .02 -------------------------------------------------------------------------------- Comparable $ 1.77 $ 1.38 $ 1.47 ================================================================================ Per share - Diluted -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2002 2001 2000 -------------------------------------------------------------------------------- Originally reported $ 1.75 $ 1.16 $ 1.45 Goodwill amortization -- .15 .01 Intangibles no longer amortized -- .06 .01 -------------------------------------------------------------------------------- Total amortization $ -- $ .21 $ .02 -------------------------------------------------------------------------------- Comparable $ 1.75 $ 1.37 $ 1.47 ================================================================================
48 Kellogg Company MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS The management of Kellogg Company is responsible for the reliability of the consolidated financial statements and related notes. The financial statements were prepared in conformity with accounting principles that are generally accepted in the United States, using our best estimates and judgements as required. We maintain a system of internal controls designed to provide reasonable assurance of the reliability of the financial statements, as well as to safeguard assets from unauthorized use or disposition. Formal policies and procedures, including an active Ethics and Business Conduct program, support the internal controls, and are designed to ensure employees adhere to the highest standards of personal and professional integrity. We have established a vigorous internal audit program that independently evaluates the adequacy and effectiveness of these internal controls. The Audit Committee of the Board of Directors meets regularly with management, internal auditors, and independent auditors to review internal control, auditing, and financial reporting matters. Both our independent auditors and internal auditors have free access to the Audit Committee. We believe these consolidated financial statements do not misstate or omit any material facts. Our formal certification to the Securities and Exchange Commission is made with our Annual Report on Form 10-K. The independent auditing firm of PricewaterhouseCoopers was retained to audit our consolidated financial statements and their report follows. /s/ C. M. Gutierrez ------------------------ C. M. Gutierrez Chairman of the Board Chief Executive Officer /s/ J. A. Bryant ------------------------ J. A. Bryant Executive Vice President Chief Financial Officer /s/ J. M. Boromisa ------------------------ J. M. Boromisa Senior Vice President Chief Accounting Officer REPORT OF INDEPENDENT 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 28, 2002 and December 31, 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets in conformity with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" which was adopted as of January 1, 2002. /s/ PRICEWATERHOUSECOOPERS LLP Battle Creek, Michigan January 29, 2003 Kellogg Company 49 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 12 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 loans and product shipments, and non-functional currency denominated third-party debt. The Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, the Company is exposed to volatility in the translation of foreign currency earnings to U.S. Dollars. Primary exposures include the U.S. Dollar versus the British Pound, Euro, Australian Dollar, Canadian Dollar, and Mexican Peso, and in the case of inter-subsidiary transactions, the British Pound versus the Euro. The Company assesses foreign currency risk based primarily on transactional cash flows and enters into forward contracts, options, and currency swaps to reduce fluctuations in net long or short currency positions. Forward contracts and options are generally less than 18 months duration. Currency swap agreements are established in conjunction with the term of underlying debt issuances. The tables below summarize forward contracts, options, and currency swaps held at year-end 2002 and 2001. All of these derivatives are valued in U.S. Dollars using year-end exchange rates, are hedges of anticipated transactions, translational exposure, or existing assets or liabilities, and mature within 18 months.
================================================================================ CONTRACTS TO SELL FOREIGN CURRENCY -------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------------- Notional Exchange Fair Currency value rate value Currency sold received (millions) (fc/1US$) (millions) ----------------------------------------------------------------------------------------------------------------------------------- 2002 2001 2002 2001 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- New Zealand Dollar (c) Australian Dollar $ 9.4 $ -- 2.04 -- ($ .5) $ -- Euro (b) U.S. Dollar 57.9 -- 1.04 -- (1.8) -- Pound Sterling (a) (b) U.S. Dollar 104.1 -- 1.59 -- (1.2) -- Canadian Dollar (a) U.S. Dollar 108.2 -- .64 -- .5 -- Euro (c) Pound Sterling 20.8 37.8 .98 1.10 (.6) (.5) Swedish Krona (c) Pound Sterling 8.6 -- 9.10 -- (.3) -- Swiss Franc (c) Pound Sterling 4.3 -- 1.41 -- (.1) -- Norwegian Krone (c) Pound Sterling 3.4 -- 7.43 -- (.1) -- Pound Sterling (c) Danish Krone 6.6 12.0 .56 .66 .8 .6 ----------------------------------------------------------------------------------------------------------------------------------- Total $ 323.3 $49.8 ($ 3.3) $ .1 ===================================================================================================================================
(a) hedge of existing assets or liabilities (b) hedge of translation exposure (c) hedge of anticipated transactions CONTRACTS TO PURCHASE FOREIGN CURRENCY
----------------------------------------------------------------------------------------------------------------------------------- Notional Exchange Fair Currency value rate value Currency purchased exchanged (millions) (fc/1US$) (millions) ----------------------------------------------------------------------------------------------------------------------------------- 2002 2001 2002 2001 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- Australian Dollar (a) U.S. Dollar $13.0 $ 1.1 1.79 1.96 $ -- $ -- Canadian Dollar (a) U.S. Dollar 11.8 1.0 1.57 1.60 (.1) -- Japanese Yen (a) U.S. Dollar 6.7 -- 119.86 -- .1 -- U.S. Dollar (c) Japanese Yen 2.2 2.9 119.76 131.58 -- .2 Pound Sterling (c) Japanese Yen .4 .5 .64 .76 -- -- Australian Dollar (c) Japanese Yen 1.1 .9 1.80 3.01 -- .1 Singapore Dollar (c) Japanese Yen .6 -- 1.73 -- -- -- Euro (a) U.S. Dollar -- 2.4 -- 1.12 -- .2 U.S. Dollar (c) Canadian Dollar 33.7 35.4 1.59 1.60 (.1) .5 U.S. Dollar (c) Australian Dollar -- 2.1 -- 2.04 -- -- Pound Sterling (c) South African Rand .7 3.0 .52 .98 (.1) 1.3 U.S. Dollar (c) South African Rand .4 .4 10.77 12.05 (.1) -- Pound Sterling (a) U.S. Dollar 5.3 1.8 1.60 .68 .2 -- ------------------------------------------------------------------------------------------------------------------------------------ Total $75.9 $51.5 ($.1) $2.3 ====================================================================================================================================
(a) hedge of existing assets or liabilities. (c) hedge of anticipated transactions
================================================================================ OPTION COLLAR CONTRACTS TO PURCHASE FOREIGN CURRENCY -------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------------------------ Notional Exchange Fair Currency Currency value rate value purchased exchanged (millions) (fc/1US$) (millions) ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2002 2001 2002 2001 ------------------------------------------------------------------------------------------------------------------------------------ PUT CALL Put Call U.S. Dollar (c) Mexican Peso $42.7 $-- 10.01 10.42 -- -- $1.6 $-- ====================================================================================================================================
(c) hedge of anticipated transactions
================================================================================ OPTION COLLAR CONTRACTS TO SELL FOREIGN CURRENCY -------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------------------------ Notional Exchange Fair Currency Currency value rate value sold received (millions) (fc/1US$) (millions) ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2002 2001 2002 2001 ------------------------------------------------------------------------------------------------------------------------------------ PUT CALL Put Call Euro (c) Pound Sterling $20.8 $-- 1.57 1.54 -- -- ($.3) $-- Mexican Peso (a) U.S. Dollar 54.0 -- 11.50 9.80 -- -- .2 -- ------------------------------------------------------------------------------------------------------------------------------------ Total $74.8 $-- ($.1) $-- ====================================================================================================================================
(a) hedge of existing assets or liabilities (c) hedge of anticipated transactions
================================================================================ CURRENCY SWAPS (millions) -------------------------------------------------------------------------------- Year of maturity Fair value Instrument -------------------------------------------------------------------------------------- characteristics 2002 2003 2004 2005 2006 2002 2001 ------------------------------------------------------------------------------------------------------------------------------------ hedge of existing Notional amt. $75.0 $75.0 $75.0 $75.0 $75.0 ($33.3) ($9.3) debt issue pay Pound Sterling/ Pay 5.302% 5.302% 5.302% 5.302% 5.302% receive U.S. Dollar Receive 4.490% 4.490% 4.490% 4.490% 4.490% ====================================================================================================================================
50 Kellogg Company INTEREST RATE RISK The Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing and future issuances of variable rate debt. Primary exposures include movements in U.S. Treasury rates, London Interbank Offered Rates (LIBOR), and commercial paper rates. The Company currently uses interest rate swaps and forward interest rate contracts to reduce interest rate volatility and funding costs associated with certain debt issues, and to achieve a desired proportion of variable versus fixed rate debt, based on current and projected market conditions. The following tables provide information on the Company's significant debt issues and related hedging instruments at year-end 2002 and 2001 (refer to the table on page 50 for currency swaps related to debt issues). For foreign currency-denominated debt, the information is presented in U.S. Dollar equivalents. Variable interest rates are based on effective rates or implied forward rates as of year-end 2002. Refer to Note 7 within Notes to Consolidated Financial Statements for further information.
================================================================================ INTEREST RATE SWAPS (millions) -------------------------------------------------------------------------------- Year of maturity Fair value Instrument ------------------------------------- characteristics 2003 2002 2001 -------------------------------------------------------------------------------- hedge of future debt issue Notional amt. $1,625.0 ($4.0) $ - pay fixed/receive variable Pay 2.40% Receive 1.40% ================================================================================ ================================================================================ FORWARD INTEREST RATE CONTRACTS (millions) -------------------------------------------------------------------------------- Notional Contract Fair value rate value Instrument ----------------------------------------------- characteristics 2002 2001 2002 2001 -------------------------------------------------------------------------------- hedge of future debt issue $200.0 $ - 3.35% ($2.0) $ - ================================================================================
========================================================================================================================= SIGNIFICANT DEBT ISSUES (millions) ------------------------------------------------------------------------------------------------------------------------- Debt Principal by year of maturity Fair value ------------------------------------------------------------------------------------------------------------------------- characteristics 2002 2003 2004 2005 2006 2011 2031 2002 2001 ------------------------------------------------------------------------------------------------------------------------- U.S. Dollar $699.3 $ 705.8 $ 717.9 fixed rate 5.500% effective rate (a) 5.640% ------------------------------------------------------------------------------------------------------------------------- Euro Dollar $500.0 $ 522.3 $ 518.3 fixed rate 6.625% effective rate (a) 6.354% ------------------------------------------------------------------------------------------------------------------------- U.S. Dollar $200.0 $ 213.6 $ 197.1 fixed rate 4.875% effective rate (a) 6.070% ------------------------------------------------------------------------------------------------------------------------- U.S. Dollar $1,000.0 $1,085.0 $1,024.3 fixed rate 6.000% effective rate (a) 6.390% ------------------------------------------------------------------------------------------------------------------------- U.S. Dollar $1,500.0 $1,689.0 $1,542.3 fixed rate 6.600% effective rate (a) 7.080% ------------------------------------------------------------------------------------------------------------------------- U.S. Dollar $1,100.0 $1,336.5 $1,186.7 fixed rate 7.450% effective rate (a) 7.620% ------------------------------------------------------------------------------------------------------------------------- U.S. Dollar $ 75.0 $ 75.0 $ 75.0 $ 75.0 $ 75.0 $ 311.9 $ 367.4 fixed rate 4.490% 4.490% 4.490% 4.490% 4.490% effective rate (b) 5.302% 5.302% 5.302% 5.302% 5.302% ------------------------------------------------------------------------------------------------------------------------- U.S. commercial paper $320.8 $409.8 $ 409.8 $ 320.8 weighted average variable 3.0% 2.0% ------------------------------------------------------------------------------------------------------------------------- Canadian commercial paper $171.1 $ - $ - $ 171.1 weighted average variable 2.5% =========================================================================================================================
(a) Effective fixed interest rate paid, as a result of debt discount and settlement of forward interest rate swap at date of debt issuance. (b) Effective fixed interest rate paid, as a result of related US$/Pound Sterling currency swap. Kellogg Company 51 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, sugar, cocoa, and paperboard. The Company uses the combination of long cash positions with suppliers, and exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted purchases over a duration of generally less than 18 months. The table below summarizes futures positions held at year-end 2002. The fair values of commodity contracts held at year-end 2001 were insignificant, and did not have a material impact on the Company's earnings or cash flows during 2002.
================================================================================ COMMODITY CONTRACTS (millions except contract price per volume) -------------------------------------------------------------------------------- Contract Contract price per unit Contract Position volume volume amount Fair value -------------------------------------------------------------------------------- Corn - long 1.3 bushels $ 2.45 $ 3.2 $ - Wheat - long 5.7 bushels 3.49 19.9 (1.0) Sugar - long .4 cwt 5.76 2.3 .2 ================================================================================
For all derivative financial and commodity instruments presented in the tables on pages 50-52, changes in fair values of these instruments and the resulting 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 these tables may be a limitation in assessing the net market risk of the Company. 52 Kellogg Company