Edgar Filing: KELLOGG CO

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 29, 2013

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-4171

KELLOGG COMPANY


State of Incorporation—Delaware		IRS Employer Identification No.38-0710690

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

Registrant’s telephone number: 269-961-2000

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

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or shorter period that the registrant was required to submit and post such files).

Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨		Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Common Stock outstanding as of July 26, 2013 — 362,440,126 shares

KELLOGG COMPANY

INDEX


	Page
PART I — Financial Information

Item 1:
Financial Statements

Consolidated Balance Sheet — June 29, 2013 and December 29, 2012		3

Consolidated Statement of Income — quarter and year-to-date periods ended June 29, 2013 and June 30, 2012		4

Consolidated Statement of Comprehensive Income – quarter and year-to-date periods ended June 29, 2013 and June 30, 2012		5

Consolidated Statement of Equity — year ended December 29, 2012 and year-to-date period ended June 29, 2013		6

Consolidated Statement of Cash Flows — year-to-date periods ended June 29, 2013 and June 30, 2012		7

Notes to Consolidated Financial Statements		8

Item 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3:
Quantitative and Qualitative Disclosures about Market Risk		38

Item 4:
Controls and Procedures		38

PART II — Other Information

Item 1A:
Risk Factors		39

Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds		39

Item 6:
Exhibits		39

Signatures		40

Exhibit Index		41

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED BALANCE SHEET

(millions, except per share data)


	June 29, 2013 (unaudited)			December 29, 2012 *
Current assets
Cash and cash equivalents	$	262		$	281
Accounts receivable, net		1,512			1,454
Inventories:
Raw materials and supplies		305			300
Finished goods and materials in process		969			1,065
Deferred income taxes		161			152
Other prepaid assets		198			128

Total current assets		3,407			3,380

Property, net of accumulated depreciation of $5,246 and $5,209		3,719			3,782
Goodwill **		5,019			5,038
Other intangibles, net of accumulated amortization of $56 and $53		2,347			2,359
Pension		171			145
Other assets		413			465


Total assets	$	15,076		$	15,169



Current liabilities
Current maturities of long-term debt	$	293		$	755
Notes payable		1,136			1,065
Accounts payable		1,364			1,402
Accrued advertising and promotion		482			517
Accrued income taxes		31			46
Accrued salaries and wages		219			266
Other current liabilities		444			472


Total current liabilities		3,969			4,523

Long-term debt		6,337			6,082
Deferred income taxes		569			523
Pension liability		869			886
Nonpension postretirement benefits		273			281
Other liabilities		440			409

Commitments and contingencies

Equity
Common stock, $.25 par value		105			105
Capital in excess of par value		568			573
Retained earnings		5,939			5,615
Treasury stock, at cost		(3,031	)		(2,943	)
Accumulated other comprehensive income (loss) **		(1,023	)		(946	)


Total Kellogg Company equity		2,558			2,404

Noncontrolling interests		61			61

Total equity		2,619			2,465

Total liabilities and equity	$	15,076		$	15,169

*	Condensed from audited financial statements.

**	Amounts have been revised as discussed in Note 2 to the financial statements.

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME

(millions, except per share data)


	Quarter ended					Year-to-date period ended
	June 29,			June 30,		June 29,			June 30,
(Results are unaudited)	2013			2012		2013			2012
Net sales	$	3,714		$	3,474	$	7,575		$	6,914

Cost of goods sold		2,237			2,035		4,705			4,122
Selling, general and administrative expense		907			920		1,797			1,746


Operating profit		570			519		1,073			1,046

Interest expense		61			89		121			122
Other income (expense), net		(5	)		7		(12	)		20


Income before income taxes		504			437		940			944
Income taxes		150			113		274			269
Earnings (loss) from joint ventures		(2	)		—		(3	)		—

Net income	$	352		$	324	$	663		$	675

Net income (loss) attributable to noncontrolling interests		—			—		—			—

Net income attributable to Kellogg Company	$	352		$	324	$	663		$	675



Per share amounts:
Basic	$	0.96		$	0.91	$	1.82		$	1.89
Diluted	$	0.96		$	0.90	$	1.81		$	1.88

Dividends per share	$	0.440		$	0.430	$	0.880		$	0.860


Average shares outstanding:
Basic		364			357		364			357

Diluted		367			359		366			359


Actual shares outstanding at period end							362			358

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(millions)


	Quarter ended June 29, 2013						Year-to-date period ended June 29, 2013
(Results are unaudited)	Pre-tax amount		Tax (expense) benefit		After-tax amount		Pre-tax amount		Tax (expense) benefit		After-tax amount

Net income					$	352					$	663
Other comprehensive income (loss):
Foreign currency translation adjustments*	$	(51)	$	—		(51)	$	(91)	$	—		(91)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		1		—		1		12		(3)		9
Reclassification to net income		(2)		—		(2)		(2)		—		(2)
Postretirement and postemployment benefits:
Reclassification to net income:
Net experience loss		1		—		1		3		—		3
Prior service cost		3		(1)		2		6		(2)		4

Other comprehensive income (loss)	$	(48)	$	(1)	$	(49)	$	(72)	$	(5)	$	(77)

Comprehensive income					$	303					$	586



	Quarter ended June 30, 2012						Year-to-date period ended June 30, 2012
(Results are unaudited)	Pre-tax amount		Tax (expense) benefit		After-tax amount		Pre-tax amount		Tax (expense) benefit		After-tax amount

Net income					$	324					$	675
Other comprehensive income (loss):
Foreign currency translation adjustments*	$	(121)	$	—		(121)	$	(26)	$	2		(24)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		—		—		—		(8)		3		(5)
Reclassification to net income		5		(2)		3		9		(3)		6
Postretirement and postemployment benefits:
Amounts arising during the period:
Net experience gain (loss)*		(3)		1		(2)		(3)		1		(2)
Prior service credit (cost)*		(10)		3		(7)		(10)		3		(7)
Reclassification to net income:
Net experience loss*		1		—		1		2		—		2
Prior service cost*		3		(1)		2		7		(2)		5

Other comprehensive income (loss)	$	(125)	$	1	$	(124)	$	(29)	$	4	$	(25)

Comprehensive income					$	200					$	650

* Amounts have been revised as discussed in Note 2 and Note 7 to the financial statements.

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF EQUITY

(millions)


	Common stock				Capital in excess of			Retained			Treasury stock						Accumulated other comprehensive			Total Kellogg Company			Non- controlling		Total			Total comprehensive
(unaudited)	shares		amount		par value			earnings			shares			amount			income (loss)			equity			interests		equity			income (loss)
Balance, December 31, 2011		419	$	105	$	522		$	5,305			62		$	(3,130	)	$	(1,006	)	$	1,796		$	2	$	1,798
Common stock repurchases												1			(63	)					(63	)				(63	)
Acquisition of noncontrolling interest																					—			59		59
Net income									961												961			—		961		$	961
Dividends									(622	)											(622	)				(622	)
Other comprehensive income*																		60			60					60			60
Stock compensation						36															36					36
Stock options exercised and other		1				15			(29	)		(5	)		250						236					236

Balance, December 29, 2012*		420	$	105	$	573		$	5,615			58		$	(2,943	)	$	(946	)	$	2,404		$	61	$	2,465		$	1,021
Common stock repurchases						(36	)					8			(508	)					(544	)				(544	)
Net income									663												663					663			663
Dividends									(320	)											(320	)				(320	)
Other comprehensive loss*																		(77	)		(77	)				(77	)		(77	)
Stock compensation						15															15					15
Stock options exercised and other						16			(19	)		(8	)		420						417					417

Balance, June 29, 2013		420	$	105	$	568		$	5,939			58		$	(3,031	)	$	(1,023	)	$	2,558		$	61	$	2,619		$	586

*	Amounts have been revised as discussed in Note 2 to the financial statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS

(millions)


	Year-to-date period ended
	June 29,			June 30,
(unaudited)	2013			2012
Operating activities
Net income	$	663		$	675
Adjustments to reconcile net income to operating cash flows:
Depreciation and amortization		226			194
Postretirement benefit plan expense (benefit)		(8	)		(10	)
Deferred income taxes		9			(32	)
Other		60			(20	)
Postretirement benefit plan contributions		(36	)		(32	)
Changes in operating assets and liabilities, net of acquisitions:
Trade receivables		(112	)		(69	)
Inventories		91			40
Accounts payable		(38	)		32
Accrued income taxes		3			(21	)
Accrued interest expense		(6	)		(1	)
Accrued and prepaid advertising, promotion and trade allowances		(53	)		48
Accrued salaries and wages		(47	)		(27	)
All other current assets and liabilities		(47	)		(97	)


Net cash provided by (used in) operating activities		705			680


Investing activities
Additions to properties		(238	)		(155	)
Acquisitions, net of cash acquired		—			(2,674	)
Other		(1	)		6


Net cash provided by (used in) investing activities		(239	)		(2,823	)


Financing activities
Net issuances of notes payable		71			500
Issuances of long-term debt		645			1,727
Reductions of long-term debt		(760	)		—
Net issuances of common stock		408			65
Common stock repurchases		(544	)		(63	)
Cash dividends		(320	)		(306	)
Other		20			(3	)


Net cash provided by (used in) financing activities		(480	)		1,920


Effect of exchange rate changes on cash and cash equivalents		(5	)		(7	)


Decrease in cash and cash equivalents		(19	)		(230	)
Cash and cash equivalents at beginning of period		281			460


Cash and cash equivalents at end of period	$	262		$	230

Refer to Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements

for the quarter ended June 29, 2013 (unaudited)

Note 1 Accounting policies

Basis of presentation

The unaudited interim financial information of Kellogg Company (the Company) included in this report reflects normal recurring adjustments that management believes are necessary for a fair statement of the results of operations, comprehensive income, financial position, equity and cash flows for the periods presented. This interim information should be read in conjunction with the financial statements and accompanying footnotes within the Company’s 2012 Annual Report on Form 10-K.

The condensed balance sheet data at December 29, 2012 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the quarterly period ended June 29, 2013 are not necessarily indicative of the results to be expected for other interim periods or the full year.

New accounting standards

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. In February 2013, the Financial Accounting Standards Board (FASB) issued an updated accounting standard that includes a requirement to present reclassification adjustments out of accumulated other comprehensive income by component either on the face of the financial statements or as a separate disclosure in the notes to the financial statements. This updated standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012 and was adopted by the Company on a prospective basis at the beginning of its 2013 fiscal year. Refer to Note 4 for disclosures required under this standard.

Note 2 Goodwill and other intangible assets

On May 31, 2012, the Company completed its acquisition of the Pringles^® business (Pringles) from The Procter & Gamble Company (P&G) for $2.695 billion, or $2.683 billion net of cash and cash equivalents, subject to certain purchase price adjustments. The net purchase price adjustments have resulted in a reduction of the purchase price by approximately $15 million. The purchase price, net of cash and cash equivalents, totals $2.668 billion. The acquisition was accounted for under the purchase method and was financed through a combination of cash on hand and short-term and long-term debt. The assets and liabilities of Pringles are included in the Consolidated Balance Sheet as of June 29, 2013 and the results of the Pringles operations subsequent to the acquisition date are included in the Consolidated Statement of Income.

The purchase price allocation, including the allocation to reportable segments, was completed in the second quarter of 2013 when the valuations of fixed assets and intangible assets were finalized resulting in a reallocation of goodwill between the Company’s reportable segments. Prior year amounts have been revised to reflect these changes as of the date of the acquisition, resulting in reductions to goodwill and the foreign currency translation component of other comprehensive income (OCI) of $15 million for 2012 and an increase to goodwill and OCI in the year-to-date period ended June 30, 2012 of $2 million.

In order to comply with the requirement that all goodwill and indefinite-lived intangible assets are tested for impairment within one year of acquisition, the Company performed an impairment evaluation of the goodwill and indefinite-lived intangible assets recognized as part of the Pringles acquisition during the quarter ended June 29, 2013. The Company determined the fair value of our goodwill and other intangible assets exceeds their carrying value and those intangibles so classified will contribute indefinitely to the cash flows of the Company.

As part of the Pringles acquisition, we incurred $16 million of integration-related costs in the second quarter of 2013 of which $13 million are recorded in selling, general and administrative (SGA) expense, $1 million are recorded in cost of goods sold (COGS), and $2 million are recorded in net sales. Integration-related costs in the year-to-date period ended June 29, 2013 were $36 million of which $27 million are recorded in SGA expense, $6 million are recorded in COGS and $3 million are recorded in net sales.

Pringles contributed net revenues of $424 million and net earnings of $34 million for the second quarter of 2013 and contributed net revenues of $794 million and net earnings of $48 million for the year-to-date period ended June 29, 2013, including the integration-related costs discussed above. The unaudited pro forma combined historical second quarter results, as if Pringles had been acquired at the beginning of fiscal 2011, are estimated to be:


(millions, except per share data)	Quarter ended June 30, 2012		Year-to-date period ended June 30, 2012
Net sales	$	3,792	$	7,579


Net income	$	341	$	705

Net income attributable to Kellogg Company	$	341	$	705


Net earnings per share	$	0.95	$	1.96

The pro forma results include interest expense on the debt issued to finance the acquisition, amortization of the definite lived intangible assets, and depreciation based on estimated fair value and useful lives. 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 2012, nor are they necessarily indicative of future consolidated results.

Changes in the carrying amount of goodwill for the year-to-date period ended June 29, 2013, are presented in the following table.

Carrying amount of goodwill


(millions)	U.S. Morning Foods		U.S. Snacks		U.S. Specialty		North America Other			Europe			Latin America			Asia Pacific			Consoli- dated
December 29, 2012	$	133	$	3,767	$	82	$	280		$	438		$	92		$	246		$	5,038
Additions		—		11		—		—			—			—			—			11
Currency translation adjustment		—		—		—		(2	)		(16	)		(3	)		(9	)		(30	)
June 29, 2013	$	133	$	3,778	$	82	$	278		$	422		$	89		$	237		$	5,019

Intangible assets subject to amortization

(millions)


Gross carrying amount	U.S. Morning Foods		U.S. Snacks			U.S. Specialty		North America Other		Europe			Latin America		Asia Pacific		Consoli- dated
December 29, 2012	$	28	$	70		$	—	$	5	$	43		$	7	$	10	$	163
Currency translation adjustment		—		—			—		—		(1	)		—		—		(1	)

June 29, 2013	$	28	$	70		$	—	$	5	$	42		$	7	$	10	$	162



Accumulated Amortization

December 29, 2012	$	28	$	12		$	—	$	3	$	3		$	7	$	—	$	53
Amortization		—		2			—		—		1			—		—		3
June 29, 2013	$	28	$	14		$	—	$	3	$	4		$	7	$	—	$	56



Intangible assets subject to amortization, net

December 29, 2012	$	—	$	58		$	—	$	2	$	40		$	—	$	10	$	110
Currency translation adjustment		—		—			—		—		(1	)		—		—		(1	)
Amortization		—		(2	)		—		—		(1	)		—		—		(3	)

June 29, 2013	$	—	$	56		$	—	$	2	$	38		$	—	$	10	$	106

For intangible assets in the preceding table, amortization was $3 million for the current year-to-date period ended June 29, 2013, compared to less than $1 million for the prior year-to-date period ended June 30, 2012. The currently estimated aggregate annual amortization expense for full-year 2013 and each of the four succeeding fiscal years is approximately $7 million.

Intangible assets not subject to amortization


(millions)	U.S. Morning Foods		U.S. Snacks		U.S. Specialty		North America Other		Europe			Latin America		Asia Pacific		Consoli- dated
December 29, 2012	$	63	$	1,625	$	—	$	95	$	466		$	—	$	—	$	2,249
Currency translation adjustment		—		—		—		—		(8	)		—		—		(8	)
June 29, 2013	$	63	$	1,625	$	—	$	95	$	458		$	—	$	—	$	2,241

Note 3 Exit or disposal activities

The Company views its continued spending on cost-reduction activities as part of its ongoing operating principles to provide greater visibility in achieving its long-term profit growth targets. Initiatives undertaken are expected to recover cash implementation costs within a five-year period of completion. Upon completion (or as each major stage is completed in the case of multi-year programs), the project begins to deliver cash savings and/or reduced depreciation.

Costs summary

During the quarter ended June 29, 2013, the Company recorded $1 million of exit costs related to two ongoing programs which the Company expects will result in COGS and SGA expense savings. The costs included $1 million of other cash costs including relocation of assets and employees in the U.S. Morning Foods reportable segment. During the year-to-date period ended June 29, 2013, the Company recorded $10 million of costs associated with exit or disposal activities. The costs included $4 million for severance, $4 million for asset write-offs and $2 million for other cash costs including relocation of assets and employees. The costs impacted reportable segments, as follows (in millions): U.S. Morning Foods $3; U.S. Snacks $1; and Asia Pacific $6. During the quarter and year-to-date periods ended June 30, 2012, the Company recorded $4 million of costs associated with exit or disposal activities. The costs included $2 million for severance in the U.S. Snacks reportable segment, $1 million of severance in the U.S. Morning Foods reportable segment and $1 million of asset write-offs in the European reportable segment. At June 29, 2013, there were no exit cost reserves for severance. Based on forecasted exchange rates, the Company currently expects to incur an additional $4 million in exit costs for these programs in 2013.

For programs that are active as of June 29, 2013, total program costs incurred to date were $30 million and include $7 million for severance, $2 million for other cash costs including relocation of assets and employees, and $21 million for asset write-offs. The costs impacted reportable segments as follows (in millions): Asia Pacific $23; U.S. Morning Foods $4; and U.S. Snacks $3.

Refer to the footnotes within the Company’s 2012 Annual Report on Form 10-K for further information on these initiatives.

Note 4 Equity

Earnings per share

Basic earnings per share is determined by dividing net income attributable to Kellogg Company by the weighted average number of common shares outstanding during the period. Diluted 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 consist principally of employee stock options issued by the Company, and to a lesser extent, certain contingently issuable performance shares. Basic earnings per share is reconciled to diluted earnings per share in the following table. There were 6 million and 4 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended June 29, 2013. The total number of anti-dilutive potential common shares excluded from the reconciliation were 17 million and 13 million for the quarter and year-to-date periods ended June 30, 2012.

Quarters ended June 29, 2013 and June 30, 2012:

(millions, except per share data)

Net income

attributable to

Kellogg Company

Average

shares

outstanding

Earnings

per share

2013

Basic

$352

364

$0.96

Dilutive potential common shares

—

Diluted

$352

367

$0.96

2012

Basic

$324

357

$0.91

Dilutive potential common shares

(0.01)

Diluted

$324

359

$0.90

Year-to-date periods ended June 29, 2013 and June 30, 2012:

(millions, except per share data)

Net income

attributable to

Kellogg Company

Average

shares

outstanding

Earnings

per share

2013

Basic

$663

364

$1.82

Dilutive potential common shares

(0.01)

Diluted

$663

366

$1.81

2012

Basic

$675

357

$1.89

Dilutive potential common shares

(0.01)

Diluted

$675

359

$1.88

In December 2012, the Company’s board of directors approved a $300 million share repurchase program for 2013, which was superseded in April 2013 by an authorization to repurchase shares up to $1 billion through April 2014. In May 2013, the Company entered into an Accelerated Share Repurchase (ASR) Agreement with a financial institution counterparty and paid $355 million for the repurchase of shares during the term of the Agreement which extends through August 2013. The total number of shares ultimately delivered, and therefore the average price paid for shares, will be determined at the end of the purchase period based on the volume weighted average price of the Company’s stock during that period. During the quarter ended June 29, 2013, 4.9 million shares were initially delivered to the Company and accounted for as a reduction to Kellogg Company equity. As of June 29, 2013, $36 million of the $355 million payment has been recorded as a reduction of capital in excess of par for the additional shares to be delivered to the Company. During the year-to-date period ended June 29, 2013, the Company repurchased approximately 8 million shares of common stock for a total of $508 million, including shares initially delivered under the ASR. During the year-to-date period ended June 30, 2012, the Company repurchased slightly more than 1 million shares of common stock for a total of $63 million.

Comprehensive income

Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by or distributions to shareholders. OCI consists of foreign currency translation adjustments, fair value adjustments associated with cash flow hedges and adjustments for net experience losses and prior service cost related to employee benefit plans.


	Quarter ended June 29, 2013									Year-to-date period ended June 29, 2013
(millions)	Pre-tax amount			Tax (expense) or benefit			After- tax amount			Pre-tax amount			Tax (expense) or benefit			After- tax amount
Net income							$	352								$	663
Other comprehensive income (loss):
Foreign currency translation adjustments	$	(51	)	$	—			(51	)	$	(91	)	$	—			(91	)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		1			—			1			12			(3	)		9
Reclassification to net earnings		(2	)		—			(2	)		(2	)		—			(2	)
Postretirement and postemployment benefits:
Reclassification to net income:
Net experience loss		1			—			1			3			—			3
Prior service cost		3			(1	)		2			6			(2	)		4

Other comprehensive income (loss)	$	(48	)	$	(1	)		(49	)	$	(72	)	$	(5	)		(77	)

Comprehensive income							$	303								$	586

Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended June 29, 2013 consisted of the following:


(millions)
Details about AOCI components	Amount reclassified from AOCI		Affected Line Item in the Statement where Net Income is Presented
	Quarter ended June 29, 2013	Year-to-date period ended June 29, 2013
Gains and losses on cash flow hedges:
Foreign currency exchange contracts	$ (3)	$ (5)	COGS
Interest rate contracts	(1)	(2)	Interest expense
Commodity contracts	2	5	COGS

	$ (2)	$ (2)	Total before tax
	—	—	Tax (expense) benefit

	$ (2)	$ (2)	Net of tax

Amortization of postretirement and postemployment benefits:
Net experience loss	$ 1	$ 3	See Note 7 for further details
Prior service cost	3	6	See Note 7 for further details

	$ 4	$ 9	Total before tax
	(1)	(2)	Tax (expense) benefit

	$ 3	$ 7	Net of tax

Total reclassifications for the quarter	$ 1	$ 5	Net of tax

Accumulated other comprehensive income (loss) as of June 29, 2013 and December 29, 2012 consisted of the following:


	June 29,		December 29,
(millions)	2013		2012
Foreign currency translation adjustments	$	(923)		$ (832)
Cash flow hedges — unrealized net gain (loss)		4		(3)
Postretirement and postemployment benefits:
Net experience loss		(26)		(29)
Prior service cost		(78)		(82)

Total accumulated other comprehensive income (loss)	$	(1,023)		$ (946)

Note 5 Debt

The following table presents the components of notes payable at June 29, 2013 and December 29, 2012:

June 29, 2013

December 29, 2012

(millions)

Principal
amount

Effective
interest rate

Principal
amount

Effective
interest rate

U.S. commercial paper

$836

0.22

$853

0.26

Europe commercial paper

241

0.18

159

0.18

Bank borrowings

Total

$1,136

$1,065

In the first quarter of 2013, the Company terminated interest rate swaps with notional amounts totaling $250 million, which were designated as fair value hedges of its 3.25% fixed rate U.S. Dollar Notes due 2018. The interest rate swaps effectively converted the interest rate on the Notes from fixed to variable and the unrealized gain upon termination of $12 million will be amortized to interest expense over the remaining term of the notes.

In the second quarter of 2013, the Company terminated interest rate swaps with notional amounts totaling $1.4 billion, which were designated as fair value hedges for (a) $750 million of its 4.45% fixed rate U.S. Dollar Notes due 2016, (b) $500 million of its 1.875% fixed rate U.S. Dollar Notes due 2016 and (c) $150 million of its 3.25% fixed rate U.S. Dollar Notes due 2018 (collectively, the Notes). The interest rate swaps effectively converted the interest rate on the Notes from fixed to variable and the unrealized gain upon termination of $41 million will be amortized to interest expense over the remaining term of the Notes.

In February 2013, the Company issued $250 million of floating rate U.S. Dollar Notes bearing interest at LIBOR plus 0.23% due February 2015 and $400 million of ten-year 2.75% U.S. Dollar Notes, resulting in aggregate net proceeds after debt discount and commissions of $645 million. The proceeds from these Notes were used for general corporate purposes, including, together with cash on hand, the repayment of $749 million aggregate principal amount of the Company’s 4.25% U.S. Dollar Notes that matured on March 6, 2013. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions, as well as a change of control provision.

In the first half of 2013, the Company entered into interest rate swaps with notional amounts totaling $1.9 billion, which effectively converted a portion of the associated U.S. Dollar Notes from fixed rate to floating rate obligations. The effective interest rates on debt obligations resulting from the Company’s interest rate swaps as of June 29, 2013 were as follows: (a) seven-year 4.45% U.S. Dollar Notes due 2016 – 3.47%; (b) five-year 1.875% U.S. Dollar Notes due 2016 – 1.02%; (c) five-year 1.75% U.S. Dollar Notes due 2017—1.36%; (d) seven-year 3.25% U.S. Dollar Notes due 2018 – 1.87%; (e) ten-year 4.15% U.S. Dollar Notes due 2019—2.75%; (f) ten-year 4.00% U.S. Dollar Notes due 2020—2.88%; (g) ten-year 3.125% U.S. Dollar Notes due 2022—2.75%. These derivative instruments were designated as fair value hedges.

Note 6 Stock compensation

The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, and to a lesser extent, executive performance shares, restricted stock units and restricted stock grants. The Company also sponsors a discounted stock purchase plan in the United States and matching-grant programs in several international locations. Additionally, the Company awards restricted stock to its outside directors. The interim information below should be read in conjunction with the disclosures included within the stock compensation footnote of the Company’s 2012 Annual Report on Form 10-K.

The Company classifies pre-tax stock compensation expense in SGA expense principally within its corporate operations. For the periods presented, compensation expense for all types of equity-based programs and the related income tax benefit recognized were as follows:

Quarter ended

Year-to-date period ended

(millions)

June 29, 2013

June 30, 2012

June 29, 2013

June 30, 2012

Pre-tax compensation expense

$12

$10

$21

$22

Related income tax benefit

$ 5

$ 4

$ 8

$ 8

As of June 29, 2013, total stock-based compensation cost related to non-vested awards not yet recognized was $64 million and the weighted-average period over which this amount is expected to be recognized was 2 years.

Stock options

During the year-to-date period ended June 29, 2013 and June 30, 2012, the Company granted non-qualified stock options to eligible employees as presented in the following activity tables. Terms of these grants and the Company’s methods for determining grant-date fair value of the awards were consistent with that described within the stock compensation footnote in the Company’s 2012 Annual Report on Form 10-K.

Year-to-date period ended June 29, 2013:

Weighted-

average

Aggregate

average

remaining

intrinsic

Employee and director stock options

Shares
(millions)

exercise
price

contractual
term (yrs.)

value
(millions)

Outstanding, beginning of period

$50

Granted

Exercised

(9)

Forfeitures and expirations

(1)

Outstanding, end of period

$53

7.4

$231

Exercisable, end of period

$50

5.8

$150

Year-to-date period ended June 30, 2012:


Employee and director stock options	Shares (millions)			Weighted- average exercise price		Weighted- average remaining contractual term (yrs.)		Aggregate intrinsic value (millions)
Outstanding, beginning of period		24			$48
Granted		6			53
Exercised		(1	)		42
Forfeitures and expirations		(1	)		53
Outstanding, end of period		28			$49		6.6		$58
Exercisable, end of period		18			$47		5.3		$58

The weighted-average fair value of options granted was $5.92 per share and $5.23 per share for the year-to-date periods ended June 29, 2013 and June 30, 2012, respectively. The fair value was estimated using the following assumptions:


	Weighted- average expected volatility			Weighted- average expected term (years)		Weighted- average risk-free interest rate			Dividend yield
Grants within the year-to-date period ended June 29, 2013:		15	%		7.44		1.49	%		2.90	%
Grants within the year-to-date period ended June 30, 2012:		16	%		7.53		1.60	%		3.30	%

The total intrinsic value of options exercised was $117 million and $13 million for the year-to-date periods ended June 29, 2013 and June 30, 2012, respectively.

Performance shares

In the first quarter of 2013, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year operating profit and internal net sales growth targets are achieved.

The 2013 target grant currently corresponds to approximately 228,000 shares, with a grant-date fair value of $54 per share. The actual number of shares issued on the vesting date could range from 0 to 200% of target, depending on actual performance achieved. Based on the market price of the Company’s common stock at June 29, 2013, the maximum future value that could be awarded to employees on the vesting date for all outstanding performance share awards was as follows:


(millions)		June 29, 2013
2011 Award		$15
2012 Award		$26
2013 Award		$29

The 2010 performance share award, payable in stock, was settled at 40% of target in February 2013 for a total dollar equivalent of $4 million.

Note 7 Employee benefits

The Company sponsors a number of U.S. and foreign pension, other nonpension postretirement and postemployment plans to provide various benefits for its employees. These plans are described within the footnotes to the Consolidated Financial Statements included in the Company’s 2012 Annual Report on Form 10-K. During the fourth quarter of 2012 the Company changed its policy for recognizing expense for its pension and postretirement benefit plans. Components of Company plan benefit expense for the periods presented are included in the tables below. All amounts have been revised to reflect the new policy.

Pension


	Quarter ended				Year-to-date period ended
(millions)	June 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Service cost		$ 34		$ 26		$ 68		$ 54
Interest cost		50		52		100		103
Expected return on plan assets		(89)		(85)		(179)		(171)
Amortization of unrecognized prior service cost		4		3		8		7

Total pension expense		$ (1)		$ (4)		$ (3)		$ (7)

Other nonpension postretirement

Quarter ended

Year-to-date period ended

(millions)

June 29, 2013

June 30, 2012

June 29, 2013

June 30, 2012

Service cost

$ 8

$ 7

$ 17

$ 13

Interest cost

Expected return on plan assets

(22)

(21)

(44)

(42)

Amortization of unrecognized prior service cost

(1)

—

(2)

—

Total postretirement benefit expense

$ (3)

$ (1)

$ (5)

$ (3)

Postemployment


	Quarter ended				Year-to-date period ended
(millions)	June 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Service cost		$ 1		$ 2		$ 3		$ 4
Interest cost		1		1		2		2
Recognized net loss		1		1		3		2

Total postemployment benefit expense		$ 3		$ 4		$ 8		$ 8

Company contributions to employee benefit plans are summarized as follows:


			Nonpension
(millions)	Pension		postretirement		Total
Quarter ended:
June 29, 2013	$	1	$	4	$	5
June 30, 2012	$	3	$	5	$	8

Year-to-date period ended:
June 29, 2013	$	28	$	8	$	36
June 30, 2012	$	24	$	9	$	33

Full year:
Fiscal year 2013 (projected)	$	45	$	17	$	62
Fiscal year 2012 (actual)	$	38	$	13	$	51

Plan funding strategies may be modified in response to management’s evaluation of tax deductibility, market conditions, and competing investment alternatives.

Note 8 Income taxes

The consolidated effective tax rate for the quarter ended June 29, 2013 was 30% as compared to the prior year’s rate of 26%. The lower effective rate for the second quarter of 2012 was primarily due to the elimination of a tax liability related to certain international earnings now considered indefinitely reinvested. The consolidated effective tax rate for the year-to-date periods ended June 29, 2013 and June 30, 2012 were 29% and 28%, respectively.

As of June 29, 2013, the Company classified $19 million related to uncertain tax positions as a net current liability, representing several income tax positions under examination in various jurisdictions. Management’s estimate of reasonably possible changes in unrecognized tax benefits during the next twelve months consists of the current liability

balance, expected to be settled within one year, offset by $9 million of projected additions. Management is currently unaware of any issues under review that could result in significant additional payments, accruals or other material deviation in this estimate.

Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the year-to-date period ended June 29, 2013; $58 million of this total represents the amount that, if recognized, would affect the Company’s effective income tax rate in future periods.


(millions)
December 29, 2012			$ 80
Tax positions related to current year:
Additions			4
Reductions			—
Tax positions related to prior years:
Additions			9
Reductions			(2)
Settlements			(11)
June 29, 2013			$ 80

For the year-to-date period ended June 29, 2013, the Company recognized expense of $4 million of tax-related interest and penalties and cash settlements of $5 million, resulting in an accrual balance of $18 million at June 29, 2013.

Note 9 Derivative instruments and fair value measurements

The Company is exposed to certain market risks such as changes in interest rates, foreign currency exchange rates, and commodity prices, which exist as a part of its ongoing business operations. Management uses derivative financial and commodity instruments, including futures, options, and swaps, where appropriate, to manage these risks. Instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged.

The Company designates derivatives as cash flow hedges, fair value hedges, net investment hedges, and uses other contracts to reduce volatility in interest rates, foreign currency and commodities. As a matter of policy, the Company does not engage in trading or speculative hedging transactions.

Total notional amounts of the Company’s derivative instruments as of June 29, 2013 and December 29, 2012 were as follows:


	June 29,		December 29,
(millions)	2013		2012
Foreign currency exchange contracts		$ 519		$ 570
Interest rate contracts		2,400		2,150
Commodity contracts		372		320

Total		$3,291		$ 3,040

Following is a description of each category in the fair value hierarchy and the financial assets and liabilities of the Company that were included in each category at June 29, 2013 and December 29, 2012, measured on a recurring basis.

Level 1 – Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market. For the Company, level 1 financial assets and liabilities consist primarily of commodity derivative contracts.

Level 2 – Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. For the Company, level 2 financial assets and liabilities consist of interest rate swaps and over-the-counter commodity and currency contracts.

The Company’s calculation of the fair value of interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the interest rate curve. Over-the-counter commodity derivatives are valued using an income approach based on the commodity index prices less the contract rate multiplied by the notional amount. Foreign

currency contracts are valued using an income approach based on forward rates less the contract rate multiplied by the notional amount. The Company’s calculation of the fair value of level 2 financial assets and liabilities takes into consideration the risk of nonperformance, including counterparty credit risk.

Level 3 – Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability. The Company did not have any level 3 financial assets or liabilities as of June 29, 2013 or December 29, 2012.

The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of June 29, 2013 and December 29, 2012:

Derivatives designated as hedging instruments


	June 29, 2013						December 29, 2012
(millions)	Level 1		Level 2		Total		Level 1		Level 2		Total
Assets:
Foreign currency exchange contracts:
Other prepaid assets		$—		$ 10		$ 10		$—		$ 4		$ 4
Interest rate contracts (a):
Other assets		—		—		—		—		64		64

Total assets		$—		$ 10		$ 10		$—		$ 68		$ 68

Liabilities:
Foreign currency exchange contracts:
Other current liabilities		$—		$ (4)		$ (4)		$—		$ (3)		$ (3)
Interest rate contracts:
Other liabilities		—		(59)		(59)		—		—		—
Commodity contracts:
Other current liabilities		—		(11)		(11)		—		(11)		(11)
Other liabilities		—		(23)		(23)		—		(27)		(27)

Total liabilities		$—		$ (97)		$ (97)		$—		$ (41)		$ (41)

(a)	The fair value of the related hedged portion of the Company’s long-term debt, a level 2 liability, was $2.5 billion as of June 29, 2013 and $2.3 billion as of December 29, 2012.

Derivatives not designated as hedging instruments


	June 29, 2013						December 29, 2012
(millions)	Level 1		Level 2		Total		Level 1		Level 2		Total
Assets:
Foreign currency exchange contracts:
Other prepaid assets		$ —		$ 1		$ 1		$ —		$—		$ —
Commodity contracts:
Other prepaid assets		4		—		4		5		—		5

Total assets		$ 4		$ 1		$ 5		$ 5		$—		$ 5


Liabilities:
Commodity contracts:
Other current liabilities		$ (19)		$—		$ (19)		$ (3)		$—		$ (3)

Total liabilities		$ (19)		$—		$ (19)		$ (3)		$—		$ (3)

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the quarters ended June 29, 2013 and June 30, 2012 was as follows:

Derivatives in fair value hedging relationships


	Location of gain (loss)	Gain (loss)
(millions)	recognized in income	recognized in income (a)
		Jun. 29,		Jun. 30,
		2013		2012
Foreign currency exchange contracts	Other income (expense), net	$	—	$	(16	)
Interest rate contracts	Interest expense		—		(1	)
Total		$	—	$	(17	)

(a)	Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives in cash flow hedging relationships


	Gain (loss)						Location of gain (loss)	Gain (loss)							Gain (loss)
	recognized in						reclassified from	reclassified from						Location of gain (loss)	recognized in
(millions)	AOCI						AOCI	AOCI into income						recognized in income (a)	income (a)
	Jun. 29,			Jun. 30,				Jun. 29,			Jun. 30,				Jun. 29,		Jun. 30,
	2013			2012				2013			2012				2013		2012
Foreign currency exchange contracts	$	3		$	1		COGS	$	3		$	—		Other income (expense), net	$	—	$	—
Foreign currency exchange contracts		—			1		SGA expense		—			1		Other income (expense), net		—		—
Interest rate contracts		—			—		Interest expense		1			1		N/A		—		—
Commodity contracts		(2	)		(2	)	COGS		(2	)		(7	)	Other income (expense), net		—		—

Total	$	1		$	—			$	2		$	(5	)		$	—	$	—

(a)	Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives in net investment hedging relationships


	Gain (loss)
	recognized in
(millions)	AOCI
	Jun. 29,		Jun. 30,
	2013		2012
Foreign currency exchange contracts	$	—	$	12

Total	$	—	$	12

Derivatives not designated as hedging instruments


(millions)	Location of gain (loss) recognized in income	Gain (loss) recognized in income
		Jun. 29,			Jun. 30,
		2013			2012
Foreign currency exchange contracts	COGS	$	1		$	—
Interest rate contracts	Interest expense		—			(27	)
Commodity contracts	COGS		(8	)		—

Total		$	(7	)	$	(27	)

The effect of derivative instruments on the Consolidated Statement of Income for the year-to-date periods ended June 29, 2013 and June 30, 2012 were as follows:

Derivatives in fair value hedging relationships


	Location of gain (loss)	Gain (loss)
(millions)	recognized in income	recognized in income (a)
		Jun. 29,		Jun. 30,
		2013		2012
Foreign currency exchange contracts	Other income (expense), net	$	3	$	(1	)
Interest rate contracts	Interest expense		1		—

Total		$	4	$	(1	)

(a)	Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives in cash flow hedging relationships


	Gain (loss)						Location of gain (loss)	Gain (loss)							Gain (loss)
	recognized in						reclassified from	reclassified from						Location of gain (loss)	recognized in
(millions)	AOCI						AOCI	AOCI into income						recognized in income (a)	income (a)
	Jun. 29,			Jun. 30,				Jun. 29,			Jun. 30,				Jun. 29,		Jun. 30,
	2013			2012				2013			2012				2013		2012
Foreign currency exchange contracts	$	12		$	(1	)	COGS	$	5		$	—		Other income (expense), net	$	—	$	—
Foreign currency exchange contracts		1			1		SGA expense		—			1		Other income (expense), net		—		—
Interest rate contracts		—			—		Interest expense		2			2		N/A		—		—
Commodity contracts		(1	)		(8	)	COGS		(5	)		(12	)	Other income (expense), net		—		—

Total	$	12		$	(8	)		$	2		$	(9	)		$	—	$	—

(a)	Includes the ineffective portion and amount excluded from effectiveness testing.

Derivatives in net investment hedging relationships


	Gain (loss)
	recognized in
(millions)	AOCI
	Jun. 29,		Jun. 30,
	2013		2012
Foreign currency exchange contracts	$	—	$	6

Total	$	—	$	6

Derivatives not designated as hedging instruments


	Location of gain (loss)	Gain (loss)
(millions)	recognized in income	recognized in income
		Jun. 29,			Jun. 30,
		2013			2012
Foreign currency exchange contracts	COGS	$	1		$	—
Interest rate contracts	Interest expense		—			(1	)
Commodity contracts	COGS		(24	)		—

Total		$	(23	)	$	(1	)

During the next 12 months, the Company expects $0.3 million of net deferred gains reported in AOCI at June 29, 2013 to be reclassified to income, assuming market rates remain constant through contract maturities.

Certain of the Company’s derivative instruments contain provisions requiring the Company to post collateral on those derivative instruments that are in a liability position if the Company’s credit rating is at or below BB+ (S&P), or Ba1 (Moody’s). The fair value of all derivative instruments with credit-risk-related contingent features in a liability position on June 29, 2013 was $86 million. If the credit-risk-related contingent features were triggered as of June 29, 2013, the Company would be required to post additional collateral of $74 million. In addition, certain derivative instruments contain provisions that would be triggered in the event the Company defaults on its debt agreements. There were no collateral posting requirements as of June 29, 2013 triggered by credit-risk-related contingent features, however, there was $12 million of collateral posted under the reciprocal agreements as discussed under counterparty credit risk concentration below.

Financial instruments

The carrying values of the Company’s short-term items, including cash, cash equivalents, accounts receivable, accounts payable and notes payable approximate fair value. The fair value of the Company’s long-term debt, which are level 2 liabilities, is calculated based on broker quotes and was as follows at June 29, 2013:


(millions)	Fair Value		Carrying Value
Current maturities of long-term debt	$	293	$	293
Long-term debt		6,792		6,337

Total	$	7,085	$	6,630

Counterparty credit risk concentration

The Company is exposed to credit loss in the event of nonperformance by counterparties on derivative financial and commodity contracts. Management believes a concentration of credit risk with respect to derivative counterparties is limited due to the credit ratings and use of master netting and reciprocal collateralization agreements with the counterparties and the use of exchange-traded commodity contracts.

Master netting agreements apply in situations where the Company executes multiple contracts with the same counterparty. Certain counterparties represent a concentration of credit risk to the Company. If those counterparties fail to perform according to the terms of derivative contracts, this would result in a loss to the Company. As of June 29, 2013, the Company was not in a significant net asset position with any counterparties with which a master netting agreement would apply.

For certain derivative contracts, reciprocal collateralization agreements with counterparties call for the posting of collateral in the form of cash, treasury securities or letters of credit if a fair value loss position to the Company or its counterparties exceeds a certain amount. As of June 29, 2013 the Company had posted collateral of $12 million in the form of cash, which was reflected as an increase in accounts receivable, net on the Consolidated Balance Sheet.

Management believes concentrations of credit risk with respect to accounts receivable is limited due to the generally high credit quality of the Company’s major customers, as well as the large number and geographic dispersion of smaller customers. However, the Company conducts a disproportionate amount of business with a small number of large multinational grocery retailers, with the five largest accounts encompassing approximately 25% of consolidated trade receivables at June 29, 2013.

Note 10 Reportable segments

Kellogg Company is the world’s leading producer of cereal, second largest producer of cookies and crackers, and a leading producer of savory snacks and frozen foods. Additional product offerings include toaster pastries, cereal bars, fruit-flavored snacks and veggie foods. Kellogg products are manufactured and marketed globally. Principal markets for these products include the United States and United Kingdom.

The Company currently manages its operations through eight operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. Beginning in the first quarter of 2013, the Kashi operating segment, which was formerly aggregated with the U.S. Morning Foods operating segment and reported as U.S. Morning

Foods and Kashi, was eliminated due to a reorganization of the business. Kashi operating segment results of prior periods were recast between U.S. Morning Foods and U.S. Snacks to conform to the current presentation. The reportable segments are discussed in greater detail below.

U.S. Morning Foods includes cereal, toaster pastries, health and wellness bars, and beverages generally marketed under the Kellogg’s name.

U.S. Snacks includes products such as cookies, crackers, cereal bars, savory snacks and fruit-flavored snacks.

U.S. Specialty primarily represents the food service, convenience and Girl Scouts businesses. The food service business is mostly non-commercial, servicing institutions such as schools and hospitals.

North America Other represents the U.S. Frozen and Canada operating segments. As these operating segments are not considered economically similar enough to aggregate with other operating segments and are immaterial for separate disclosure, they have been grouped together as a single reportable segment.

The three remaining reportable segments are based on geographic location – Europe which consists principally of European countries; Latin America which is comprised of Central and South America and includes Mexico; and Asia Pacific which is comprised of South Africa, Australia and other Asian and Pacific markets.

The measurement of reportable segment results is based on segment operating profit which is generally consistent with the presentation of operating profit in the Consolidated Statement of Income. Intercompany transactions between operating segments were insignificant in all periods presented. Segment operating profit excludes unrealized gains and losses on certain commodity hedging activities, certain components of our postemployment benefit plans, and general corporate expenses. Once realized, the gains and losses on certain commodity hedging activities are recognized within the segment results in the same period in which the underlying transaction being economically hedged is included in earnings. We exclude certain components of our postemployment benefit plans from segment operating profit because we centrally manage postemployment benefit plan funding decisions as well as the determination of discount rate, expected rate of return on plan assets and other actuarial assumptions. We also manage market-based impacts to these benefit plans centrally. Therefore we allocate only the service cost and amortization of prior service cost components of our pension and nonpension postretirement plan expense to segment operating profit.


	Quarter ended						Year-to-date period ended
(millions)	June 29, 2013			June 30, 2012			June 29, 2013			June 30, 2012
Net sales
U.S. Morning Foods	$	863		$	892		$	1,774		$	1,789
U.S. Snacks		917			850			1,818			1,636
U.S. Specialty		272			252			651			600
North America Other		388			369			791			737
Europe		723			613			1,415			1,151
Latin America		304			274			612			544
Asia Pacific		247			224			514			457

Consolidated	$	3,714		$	3,474		$	7,575		$	6,914
Operating profit
U.S. Morning Foods	$	180		$	178		$	343		$	331
U.S. Snacks		130			121			236			244
U.S. Specialty		62			56			140			127
North America Other		78			70			153			140
Europe		75			64			146			134
Latin America		42			48			90			99
Asia Pacific		17			17			38			50

Total Reportable Segments		584			554			1,146			1,125
Corporate		(14	)		(35	)		(73	)		(79	)
Consolidated	$	570		$	519		$	1,073		$	1,046

KELLOGG COMPANY

PART I—FINANCIAL INFORMATION

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

Results of operations

Overview

For more than 100 years, consumers have counted on Kellogg for great-tasting, high-quality and nutritious foods. Kellogg is the world’s leading producer of cereal, second largest producer of cookies and crackers, and a leading producer of savory snacks and frozen foods. Additional product offerings include toaster pastries, cereal bars, fruit-flavored snacks and veggie foods. Kellogg products are manufactured and marketed globally.

We manage our operations through eight operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. We report results of operations in the following reportable segments: U.S. Morning Foods; U.S. Snacks; U.S. Specialty; North America Other; Europe; Latin America; and Asia Pacific.

We manage our Company for sustainable performance defined by our long-term annual growth targets. These targets are 3 to 4% for internal net sales, mid-single-digit (4 to 6%) for underlying internal operating profit, and high-single-digit (7 to 9%) for currency-neutral underlying diluted net earnings per share.

Internal net sales and internal operating profit growth of our reportable segments exclude the impact of foreign currency translation and, if applicable, acquisitions, dispositions and integration costs associated with the acquisition of the Pringles^® business (Pringles). In addition to these items, internal operating profit growth also includes the benefit of allocating a portion of costs related to our support functions that are now being leveraged to provide support to the Pringles business.

Comparability of certain financial measures is impacted significantly by the mark-to-market adjustments that are recorded for pensions and commodity derivative contracts. To provide increased transparency and assist in understanding our underlying operating performance we use non-GAAP financial measures within the MD&A that exclude the impact of mark-to-market adjustments. These non-GAAP financial measures include underlying gross margin, underlying gross profit, underlying SGA%, underlying operating margin, underlying operating profit, underlying internal operating profit growth, underlying income taxes, underlying net income attributable to Kellogg Company, underlying basic earnings per share (EPS), underlying diluted EPS, and underlying diluted EPS growth. Underlying internal operating profit growth excludes the impact of foreign currency translation, mark-to-market adjustments, and, if applicable, acquisitions, dispositions, and integration costs associated with the acquisition of the Pringles business.

For the quarter ended June 29, 2013, our reported net sales, which includes the impact of the operating results of the Pringles business and integration costs related to the acquisition of Pringles, increased by 7% while internal net sales declined by 0.5%. We experienced internal net sales declines for the quarter in three of our reportable segments: U.S. Morning Foods, U.S. Snacks and Europe. Our Latin America and Asia-Pacific reportable segments reported solid increases. Reported operating profit, which includes the impact of mark-to-market accounting, the operating results of the Pringles business, and integration costs related to the acquisition of Pringles, increased by 10%. Underlying internal operating profit increased by 3% due to favorable overhead leverage and synergies resulting from the Pringles acquisition, continued cost discipline, as well as brand-building efficiencies and timing. These improvements offset the negative impact of inflation, net of cost savings.

Diluted EPS for the quarter of $.96 was up 7% compared to the prior year EPS of $.90. Underlying EPS of $.97 was up 8% compared to prior year EPS of $.90, in line with our expectations.

Reconciliation of certain non-GAAP Financial Measures


		Quarter ended						Year-to-date period ended

Consolidated results (dollars in millions, except per share data)		June 29, 2013			June 30, 2012			June 29, 2013			June 30, 2012


Net sales		$	3,714		$	3,474		$	7,575		$	6,914
Net sales growth:	As reported		6.9	%		2.6	%		9.6	%		0.6	%
	Acquisitions (a)		8.0			3.5			9.5			1.7
	Dispositions (b)		—			(0.2	)		(0.1	)		(0.3	)
	Integration impact (c)		(0.1	)		—			—			—
	Foreign currency impact		(0.5	)		(3.0	)		(0.6	)		(1.9	)

	Internal (d)		(0.5	)%		2.3	%		0.8	%		1.1	%


Reported operating profit		$	570		$	519		$	1,073		$	1,046
Mark-to-market (e)			(7	)		—			(61	)		(50	)

Underlying operating profit (f), (g)		$	577		$	519		$	1,134		$	1,096

Operating profit growth:
	As reported		9.6	%		(9.3	)%		2.5	%		(11.9	)%
	Acquisitions (a)		5.6			1.8			6.7			0.9
	Dispositions (b)		0.1			0.5			(0.1	)		0.5
	Integration impact (c)		3.3			(5.5	)		(0.4	)		(2.6	)
	Foreign currency impact		(1.5	)		(2.1	)		(1.4	)		(1.4	)

	Internal operating profit growth (d)		2.1	%		(4.0	)%		(2.3	)%		(9.3	)%
	Mark-to-market (e)		(1.3	)%		0.6	%		(1.0	)%		(4.5	)%

	Underlying internal (f)		3.4	%		(4.6	)%		(1.3	)%		(4.8	)%

Reported income taxes		$	150		$	113		$	274		$	269
Mark-to-market (e)			(2	)		—			(19	)		(15	)

Underlying income taxes (f)		$	152		$	113		$	293		$	284

Reported net income attributable to Kellogg Company		$	352		$	324		$	663		$	675
Mark-to-market (e)			(5	)		—			(42	)		(35	)

Underlying net income attributable to Kellogg Company (f), (g)		$	357		$	324		$	705		$	710

Reported basic EPS		$	0.96		$	0.91		$	1.82		$	1.89
Mark-to-market (e)			(0.02	)		—			(0.12	)		(0.10	)

Underlying basic EPS (f)		$	0.98		$	0.91		$	1.94		$	1.99
Underlying basic EPS growth (f)			7.7	%		(9.9	)%		(2.5	)%		(4.3	)%

Reported diluted EPS		$	0.96		$	0.90		$	1.81		$	1.88
Mark-to-market (e)			(0.01	)		—			(0.11	)		(0.10	)

Underlying diluted EPS (f)		$	0.97		$	0.90		$	1.92		$	1.98
Underlying diluted EPS growth (f)			7.8	%		(10.0	)%		(3.0	)%		(4.3	)%

(a)	Impact of results for the quarters and year-to-date periods ended June 29, 2013 and June 30, 2012 from the acquisition of Pringles.

(b)	Impact of results for the quarters and year-to-date periods ended June 29, 2013 from the divestiture of China cereal and snacks businesses.

(c)	Includes impact of transaction and integration costs associated with the Pringles acquisition.

(d)

Internal net sales and operating profit growth excludes the impact of acquisitions, divestitures, integration costs, and currency. Internal net sales and operating profit growth are a non-GAAP financial measure further discussed and reconciled to the directly comparable measure in accordance with U.S. GAAP in the net sales and operating profit section.

(e)

Includes mark-to-market adjustments for pension plans and commodity contracts as reflected in cost of goods sold. Actuarial gains/losses for pension plans are recognized in the year they occur. In 2012, actual asset returns exceeded expectations by $211 million but discount rates fell almost 100 basis points for pension plans resulting in an unfavorable mark-to-market adjustment recorded in earnings in the fourth quarter of 2012. A portion of the 2012 pension mark-to-market adjustment was capitalized as an inventoriable cost at the end of 2012. This amount has been recorded in earnings in the first quarter of 2013. During the second quarter of 2013 there were no pension mark-to-market adjustments recorded to earnings. In 2011, actual asset returns were lower than expected by $471 million and discount rates declined resulting in an unfavorable mark-to-market adjustment recorded in earnings in the fourth quarter of 2011. A portion of the 2011 pension mark-to-market adjustment was capitalized as an inventoriable cost at the end of 2011. This amount was recorded in earnings in the first quarter of 2012. Mark-to-market adjustments for commodities reflect the changes in the fair value of contracts for the difference between contract and market prices for the underlying commodities. The resulting gains/losses are recognized in the quarter they occur.

(f)

Underlying operating profit, underlying internal operating profit growth, underlying income taxes, underlying net income attributable to Kellogg Company, underlying basic EPS, underlying basic EPS growth, underlying diluted EPS, and underlying diluted EPS growth are non-GAAP measures that exclude the impact of mark-to-market adjustments for pension plans and commodity contracts. Underlying internal operating profit growth excludes the impact of foreign currency translation, mark-to-market adjustments, and, if applicable, acquisitions, dispositions, and transaction and integration costs associated with the acquisition of Pringles. We believe the use of such non-GAAP measures provides increased transparency and assists in understanding our underlying operating performance. These non-GAAP measures are reconciled to the directly comparable measures in accordance with U.S. GAAP within this table.

(g)

Underlying operating profit for the quarters ended June 29, 2013 and June 30, 2012 includes postretirement benefit plan expense (income) of ($4) million and ($5) million, respectively. Underlying operating profit for the year-to-date periods ended June 29, 2013 and June 30, 2012 includes postretirement benefit plan expense (income) of ($8) million and ($10) million, respectively.

Underlying net income attributable to Kellogg Company for the quarters ended June 29, 2013 and June 30, 2012 includes postretirement benefit plan expense (income) of ($3) million and ($4) million, respectively. Underlying net income attributable to Kellogg Company for the year-to-date periods ended June 29, 2013 and June 30, 2012 includes postretirement benefit plan expense (income) of ($6) million and ($7) million, respectively.

Net sales and operating profit

The following table provides an analysis of net sales and operating profit performance for the second quarter of 2013 versus 2012:


(dollars in millions)	U.S. Morning Foods			U.S. Snacks			U.S. Specialty			North America Other			Europe			Latin America			Asia Pacific
2013 net sales	$	863		$	917		$	272		$	388		$	723		$	304		$	247

2012 net sales	$	892		$	850		$	252		$	369		$	613		$	274		$	224

% change—2013 vs. 2012:
Internal business (a)		(3.3	)%		(3.2	)%		1.9	%		3.9	%		(.3	)%		5.0	%		4.1	%
Acquisitions (b)		—	%		11.2	%		6.2	%		2.2	%		18.4	%		6.5	%		13.8	%
Dispositions (c)		—	%		—	%		—	%		—	%		—	%		—	%		(1.2	)%
Integration (d)		—	%		—	%		—	%		—	%		—	%		—	%		(.6	)%
Foreign currency impact		—	%		—	%		—	%		(1.1	)%		(.2	)%		(.2	)%		(6.1	)%
Total change		(3.3	)%		8.0	%		8.1	%		5.0	%		17.9	%		11.3	%		10.0	%



(dollars in millions)	U.S. Morning Foods			U.S. Snacks			U.S. Specialty			North America Other			Europe			Latin America			Asia Pacific
2013 operating profit	$	180		$	130		$	62		$	78		$	75		$	42		$	17


2012 operating profit	$	178		$	121		$	56		$	70		$	64		$	48		$	17


% change—2013 vs. 2012:
Internal business (a)		1.9	%		—	%		2.3	%		12.5	%		1.8	%		(8.3	)%		11.3	%
Acquisitions (b)		—	%		11.9	%		8.0	%		.2	%		11.2	%		7.6	%		6.3	%
Dispositions (c)		—	%		—	%		—	%		—	%		—	%		—	%		3.4	%
Integration (d)		—	%		(5.0	)%		—	%		(.1	)%		6.9	%		(.2	)%		(10.3	)%
Foreign currency impact		—	%		—	%		—	%		(1.2	)%		(1.4	)%		(9.1	)%		(9.0	)%

Total change		1.9	%		6.9	%		10.3	%		11.4	%		18.5	%		(10.0	)%		1.7	%

(a)

Internal net sales and operating profit growth for 2013 exclude the impact of acquisitions, divestitures, integration costs and the impact of currency. Internal net sales and operating profit growth are non-GAAP financial measures which are reconciled to the directly comparable measures in accordance with U.S. GAAP within these tables.

(b)	Impact of results for the quarters ended June 29, 2013 and June 30, 2012 from the acquisition of Pringles.

(c)	Impact of results for the quarter ended June 29, 2013 from the divestiture of the China cereal business.

(d)	Includes impact of integration costs associated with the Pringles acquisition.

Internal net sales for U.S. Morning Foods declined 3% as a result of decreased volume which was partially offset by improved pricing/mix. This segment consists of cereal, toaster pastries, health and wellness bars, and beverages. Cereal category growth has been challenging, as expected, due to the timing of innovation scheduled for launch mid-year. Despite this category performance, Special K^®, Raisin Bran^®, and Frosted Flakes^® all posted increased consumption during the quarter. Toaster pastries reported solid consumption growth and share gains. Beverages continued to report increased consumption resulting from expanded distribution.

Internal net sales in U.S. Snacks declined 3% as a result of unfavorable pricing/mix and decreased volume. This segment consists of cookies, crackers, cereal bars, fruit-flavored snacks, and Pringles. The sales performance was partially the result of the crackers and bars businesses lapping strong growth from the prior year. The bars business continued to see positive results from Special K Pastry Crisps^® and Nutri-grain Fruit Crunch^® innovations. The cookies business declined during the quarter, although recently launched innovations are off to a good start. We anticipate improvement in these businesses in the second half of the year behind additional innovations and promotional activity, although we do expect the environment to remain challenging.

Internal net sales in U.S. Specialty increased by 2% as a result of increased volume being partially offset by unfavorable pricing/mix. Sales growth was driven by good results in both the convenience and Pringles businesses.

Internal net sales in North America Other (U.S. Frozen and Canada) increased by 4% due to favorable pricing/mix and increased volume. Sales growth was driven by strong U.S. Frozen business growth resulting from increased brand-building support behind innovation activity and distribution gains. Sales in the Canada business were down as a result of the continuation of competitive pressures.

Europe’s internal net sales was down slightly as a result of decreased volume being partially offset by improved pricing/mix. During the quarter we grew sales in the UK and the Mediterranean region. This was offset by weakness in continental Europe. Latin America’s internal net sales growth was 5% due to improved pricing/mix that more than offset decreased volume. Results in Latin America were impacted by the continued reduction in trade inventory levels. Internal net sales in Asia Pacific increased 4% as a result of increased volume which was offset by unfavorable pricing/mix. Australia contributed to this growth on good results from beverage innovations. India, Southeast Asia, and South Africa reported double-digit growth.

Internal operating profit in U.S. Morning Foods improved by 2% due to favorable timing of overhead and brand-building investments being partially offset by a decline in sales. U.S. Snacks was flat due to reduced sales being offset by favorable timing of overhead and brand-building investments. U.S. Specialty improved by 2% as a result of sales growth which was partially offset by the impact of inflation. North America Other improved by 13% as a result of sales growth which was partially offset by the impact of inflation and increased brand-building investment. Europe improved by 2% due to the favorable timing of overhead investments which was partially offset by inflation and increased brand-building investment. Latin America declined by 8% due to sales growth being offset by the significant impact of inflation and the continued impact from the reduction in trade inventory levels. Asia Pacific improved by 11% primarily due to sales growth.

The following table provides an analysis of net sales and operating profit performance for the year-to-date periods of 2013 as compared to 2012.


(dollars in millions)	U.S. Morning Foods			U.S. Snacks			U.S. Specialty			North America Other			Europe			Latin America			Asia Pacific
2013 net sales	$	1,774		$	1,818		$	651		$	791		$	1,415		$	612		$	514

2012 net sales	$	1,789		$	1,636		$	600		$	737		$	1,151		$	544		$	457

% change—2013 vs. 2012:
Internal business (a)		(.8	)%		(2.5	)%		2.8	%		5.7	%		1.1	%		6.2	%		2.2	%
Acquisitions (b)		—	%		13.6	%		5.7	%		2.7	%		22.6	%		7.6	%		17.4	%
Divestitures (c)		—	%		—	%		—	%		—	%

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