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Kellogg Co – ‘10-Q’ for 3/31/01

On:  Friday, 5/11/01, at 4:26pm ET   ·   For:  3/31/01   ·   Accession #:  950124-1-501003   ·   File #:  1-04171

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 5/11/01  Kellogg Co                        10-Q        3/31/01    7:697K                                   Bowne - Bde

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    239K 
 2: EX-4.01     Indenture Dated March 15, 2001                        75    379K 
 3: EX-4.02     Supplemental Indenture Dated March 29, 2001           67    205K 
 4: EX-10.01    Agreement Between Company and Sam Reed                12     52K 
 5: EX-10.02    Amendment Dated February 22, 2001                      4     15K 
 6: EX-10.03    Agreement Between Company and David Vermylen          13     54K 
 7: EX-10.04    Amendment Dated February 22, 2001                      4     15K 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2001
OR
		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from _______ to _______

Commission file number 1-4171

KELLOGG COMPANY

One Kellogg Square, P.O. Box 3599, Battle Creek, MI 49016-3599

Registrant’s telephone number: 616-961-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes    No

Common Stock outstanding April 30, 2001 — 405,888,504 shares

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KELLOGG COMPANY

INDEX

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Kellogg Company and Subsidiaries

Refer to Notes to Consolidated Financial Statements

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Kellogg Company and Subsidiaries

Refer to Notes to Consolidated Financial Statements

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Kellogg Company and Subsidiaries

Refer to Notes to Consolidated Financial Statements

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1. Accounting policies

The unaudited interim financial information included herein reflects the adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results of operations, financial position, and cash flows for the periods presented. Such interim information should be read in conjunction with the financial statements and notes thereto contained on pages 24 to 39 of the Company’s 2000 Annual Report. The accounting policies used in preparing these financial statements are the same as those summarized in the Company’s 2000 Annual Report, except as discussed in Note 6 below. Certain amounts for 2000 have been reclassified to conform to current-period classifications.

The results of operations for the three months ended March 31, 2001, are not necessarily indicative of the results to be expected for other interim periods or the full year.

2. Acquisitions

Keebler acquisition

On March 26, 2001, the Company completed its acquisition of Keebler Foods Company (“Keebler”), in a transaction entered into with Keebler and with Flowers Industries, Inc., the majority shareholder of Keebler. Keebler, headquartered in Elmhurst, Illinois, ranks second in the United States in the cookie and cracker categories and has the third largest food direct store door (DSD) delivery system in the United States.

Under the purchase agreement, the Company paid $42 in cash for each common share of Keebler or approximately $3.65 billion, including $66 million of related acquisition costs. The Company also assumed $205 million in obligations to cash out employee and director stock options, resulting in a total cash outlay for Keebler stock of approximately $3.85 billion. Additionally, the Company assumed approximately $700 million of Keebler debt, bringing the total value of the transaction to $4.55 billion. Approximately 80% of the debt assumed was paid off on the acquisition date.

The acquisition was accounted for under the purchase method and was financed through a combination of short-term and long-term debt. The assets and liabilities of the acquired business are included in the consolidated balance sheet as of March 31, 2001. For purposes of consolidated reporting during 2001, Keebler’s interim results of operations will be reported for the periods ended March 24, 2001, June 16, 2001, October 6, 2001, and December 29, 2001. Therefore, the Company’s first quarter 2001 results do not include any earnings from Keebler operations.

The components of intangible assets included in the initial allocation of purchase price, along with the related straight-line amortization periods, are presented in the following table. The Company is in the process of finalizing fair value appraisals of various assets and obligations that existed as of the acquisition date. As a result, the amount of goodwill could change upon completion of this work.

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The initial purchase price allocation included $90.6 million of liabilities related to management’s plans to exit certain activities and operations of the acquired company (“exit liabilities”), as presented in the table below. Cash outlays related to these exit plans are projected to be approximately $54 million in 2001, with substantially all remaining amounts in 2002.

Exit plans implemented thus far include communication of separation benefits to approximately 70 Keebler administrative employees and the announced closing of a bakery in Denver, Colorado, by May 31, 2001, eliminating approximately 470 employee positions.

The unaudited pro forma combined historical first quarter results, as if Keebler Foods Company had been acquired at the beginning of fiscal 2001 and 2000, respectively, are estimated to be:

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

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completed as of the beginning of each of the fiscal periods presented, nor are they necessarily indicative of future consolidated results.

Prior-year 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. In June, the Company acquired the outstanding stock of Kashi Company, a U.S. natural foods company, for approximately $33 million. In July, the Company purchased certain assets and liabilities of The Healthy Snack People business, an Australian convenience foods operation, for approximately $12 million.

3. Restructuring charges

During the past several years, management has commenced major productivity and operational streamlining initiatives in an effort to optimize the Company’s cost structure. The incremental costs of these programs have been reported during these years as restructuring charges. Refer to pages 30-31 of the Company’s 2000 Annual Report for more information on these initiatives.

Operating profit for the three months ended March 31, 2001, includes restructuring charges of $48.3 million ($30.3 million after tax or $.07 per share), related to integration of the Kellogg and Keebler business models and continued actions supporting the Company’s “focus and align” strategy. Specific initiatives include a headcount reduction of about 35 in the U.S. business and global layer of 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 South East Asia. Approximately 70% of the charges are comprised of asset write-offs, with the remainder consisting of employee severance and other cash costs.

Total cash outlays during the March 2001 year-to-date period for ongoing streamlining initiatives were approximately $14 million, compared to $24 million in 2000. Expected cash outlays are approximately $32 million for the remainder of 2001 and $8 million after 2001.

The components of restructuring charges, as well as reserve balance changes, during the three months ended March 31, 2001, were (in millions):

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As a result of the Keebler acquisition, the Company assumed $14.9 million of reserves for severance and facility closures, related to Keebler’s ongoing restructuring and acquisition-related synergy initiatives.

The restructuring-related reserves are attributable to the closing of Keebler’s manufacturing facility in Sayreville, New Jersey, in 1999, and are expected to be utilized during the remainder of 2001. The acquisition-related reserves are attributable primarily to the closing of various distribution and manufacturing facilities. Of the acquisition-related reserves, approximately $6 million is expected to be utilized in 2001. The remaining balance of approximately $8 million is attributable primarily to non-cancelable lease obligations extending through 2006.

4. Equity

Earnings per share

Basic net earnings per share is determined by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted net earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares are comprised principally of employee stock options issued by the Company and had an insignificant impact on earnings per share during the periods presented. Basic net earnings per share is reconciled to diluted net earnings per share as follows (in millions, except per share data):

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Comprehensive Income

Comprehensive income includes all changes in equity during a period except those resulting from investments by or distributions to shareholders. For the Company, comprehensive income for the periods presented consists of net earnings, 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:

Accumulated other comprehensive income (loss) as of March 31, 2001, and December 31, 2000 consisted of the following:

5. Debt

Notes payable at March 31, 2001, consist primarily of short-term debt borrowings in the United States in the amount of $846.5 million with an effective interest rate of 5.7%. Long-term debt consists primarily of fixed rate issuances of U.S. and Euro Dollar Notes, as follows:

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In order to provide additional short-term liquidity in connection with the Keebler Foods Company acquisition referenced above, the Company entered into a 364-Day Credit Agreement, a Five-Year Credit Agreement, and a Bridge Credit Agreement, each dated as of January 19, 2001. The Bridge Credit Agreement would have permitted the Company to borrow up to $4.0 billion, but was terminated by the Company as of March 29, 2001, after the Company issued the $4.6 billion of long-term debt instruments described above. Each of the 364-Day Credit Agreement, which expires in January 2002 (subject to a renewal option), and the Five-Year Credit Agreement, which expires in January 2006, permits the Company or certain subsidiaries to borrow up to $1.15 billion (or certain amounts in foreign currencies under the Five-Year Credit Agreement). These two credit agreements contain standard warranties, events of default, and covenants. They also require the maintenance of at least $700 million of consolidated net worth and a consolidated interest expense coverage ratio (as defined) of at least 3.0, and limit capital lease obligations and subsidiary debt. These credit facilities were unused at March 31, 2001.

Keebler Foods Company is also a party to a note purchase and servicing agreement, which contains standard warranties, events of default, covenants, as well as the financial covenants in the prior paragraph. The agreement also contains limits on indebtedness, dividends, loans and other investments, capital expenditures, affiliate transactions, and sales of assets and stock of subsidiaries.

6. Accounting for derivative instruments and hedging activities

On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133 “Accounting for Derivative Instruments and Hedging Activities.” This statement requires that all derivative instruments be recorded on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. For the three months ended March 31, 2001, the Company reported a charge to earnings of $1.0 million (net of tax benefit of $.6 million) and a charge to other comprehensive income of $14.9 million (net of tax benefit of $8.6 million) in order to recognize the fair value of derivative instruments as either assets or liabilities on the balance sheet. The charge to earnings relates to the component of the derivative instruments’ net loss that has been excluded from the assessment of hedge effectiveness.

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

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effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the contract. 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 related to the ineffective portion of any hedge are recorded in other income (expense), net. This amount was insignificant during the first quarter of 2001.

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 March 31, 2001, was $56.7 million, primarily related to a forward-starting interest rate swap (refer to Note 5), which will be reclassified into interest expense over periods of five to thirty years beginning in the second quarter of 2001. Other insignificant amounts related to foreign currency and commodity price cash flow hedges will be reclassified into earnings during the next twelve 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 held by the parent company 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 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 product shipments, and intercompany loans. The Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, the Company is exposed to volatility in the translation of foreign currency earnings to U.S. Dollars. The Company assesses foreign currency risk based on transactional cash flows and enters into forward contracts, all of generally less than twelve months duration, to reduce fluctuations in net long or short currency positions.

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For foreign currency cash flow and fair value hedges, the assessment of effectiveness is based on changes in spot rates. Changes in time value are reported in other income (expense), net.

Interest rate risk

The Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing issuances of variable rate debt. The Company currently uses interest rate swaps, including forward-starting swaps, to reduce interest rate volatility and funding costs associated with certain debt issues, and to achieve a desired proportion of variable versus fixed rate debt, based on current and projected market conditions.

Variable-to-fixed interest rate swaps are accounted for as cash flow hedges and the assessment of effectiveness is based on changes in the present value of interest payments on the underlying debt. Fixed-to-variable interest rate swaps are accounted for as fair value hedges and the assessment of effectiveness is based on changes in the fair value of the underlying debt, using incremental borrowing rates currently available on loans with similar terms and maturities.

Price risk

The Company is exposed to price fluctuations primarily as a result of anticipated purchases of raw and packaging materials. The Company uses the combination of long cash positions with suppliers, and exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted purchases over a duration of generally less than one year.

Commodity contracts are accounted for as cash flow hedges. The assessment of effectiveness is based on changes in futures prices.

7. Operating Segments

Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles, meat alternatives, pie crusts, and ice cream cones. Kellogg products are manufactured in 19 countries and marketed in more than 160 countries around the world.

The Company is managed in two major divisions — the United States and International — with International further delineated into Europe, Latin America, Canada, Australia, and Asia. This organizational structure is the basis of the operating segment data presented below.

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The measurement of operating segment results is generally consistent with the presentation of the Consolidated Statement of Earnings. Intercompany transactions between reportable operating segments were insignificant in the periods presented.

8. Recently issued pronouncements

In April 2001, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached consensus on Issue No. 00-25 “Vendor Income Statement Characterization of Consideration to a Purchaser of the Vendor’s Products or Services.” The EITF also delayed the effective date of previously finalized Issue No. 00-14 “Accounting for Certain Sales Incentives” to coincide with the effective date of Issue No. 00-25. Furthermore, the EITF has combined these Issues for purposes of publishing consensus guidance. This guidance will now be effective for Kellogg Company beginning January 1, 2002.

Both of these Issues provide guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. Generally, non-cash consideration is to be classified as a cost of sales.

This guidance is applicable to Kellogg Company in several ways. First, it applies to payments made by the Company to its customers (the retail trade) primarily for conducting consumer promotional activities, such as in-store display and feature price discounts on the Company’s products. Second, it applies to discount coupons and other cash redemption offers that the Company provides directly to consumers. Third, it applies to promotional items such as toys that the Company inserts in or attaches to its product packages (“package inserts”). Consistent with industry practice, the Company has historically classified these items as promotional expenditures within selling, general, and

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administrative expense (SG&A), and has generally recognized the cost as the related revenue is earned.

Effective January 1, 2002, the Company will reclassify promotional payments to its customers and the cost of consumer coupons and other cash redemption offers from SG&A to net sales. The Company will reclassify the cost of package inserts from SG&A to cost of sales. All comparative periods will be restated. Management is currently assessing the total combined impact of both Issues, including the proforma effect of the Keebler acquisition. However, management believes that based on historical information, combined net sales could be reduced up to 15%, with approximately 95% of this impact reflected in the U.S. operating segment. Combined cost of goods sold could be increased by approximately 1.5%. SG&A would be correspondingly reduced such that net earnings will not be affected.

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KELLOGG COMPANY

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of operations

Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles, meat alternatives, pie crusts, and ice cream cones. Kellogg products are manufactured in 19 countries and marketed in more than 160 countries around the world. The Company is managed in two major divisions — the United States and International — with International further delineated into Europe, Latin America, Canada, Australia, and Asia. This organizational structure is the basis of the operating segment data presented in this filing.

During the first quarter of 2001, we completed our acquisition of Keebler Foods Company (the “Keebler acquisition”), making Kellogg Company a leading competitor in the U.S. cookie and cracker categories. Consistent with our previously announced “focus and align” strategy, we increased investment in our U.S. cereal business, and prepared for integration of the Keebler business during the quarter. As expected, we experienced short-term disruptions in sales related to refocusing various international markets and reducing certain U.S. convenience foods inventory, anticipating the future distribution of these products through Keebler’s direct store door (DSD) delivery system. Unfavorable foreign currency movements also significantly impacted sales and operating profit. As a result, consolidated net sales and earnings for the quarter were down from the prior-year period. However, sales and dollar market share were up in the U.S. retail cereal business.

During the first quarter of 2001, we reported restructuring charges of $48.3 million ($30.3 million after tax or $.07 per share) related to integration of the Kellogg and Keebler business models and continued actions supporting our “focus and align” strategy. First quarter 2001 net earnings also included an extraordinary loss related to extinguishment of long-term debt and a charge to net earnings for the cumulative effect of an accounting change. These items have been excluded from all applicable amounts presented below for purposes of comparison between years. Reported results for the quarter are reconciled to comparable results, as follows:

The year-to-date decrease in earnings per share of $.10 consisted of $.04 from business investment, $.04 from a higher effective tax rate due primarily to the Keebler acquisition, and $.02 from unfavorable foreign currency movements.

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The following tables provide an analysis of net sales and operating profit performance for the first quarter 2001: