Edgar Filing: KELLOGG CO

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 September 28, 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 October 26, 2013 — 362,197,285 shares

KELLOGG COMPANY

INDEX


	Page
PART I — Financial Information

Item 1:
Financial Statements

Consolidated Balance Sheet — September 28, 2013 and December 29, 2012		3

Consolidated Statement of Income — quarter and year-to-date periods ended September 28, 2013 and September 29, 2012		4

Consolidated Statement of Comprehensive Income – quarter and year-to-date periods ended September 28, 2013 and September 29, 2012		5

Consolidated Statement of Equity — year ended December 29, 2012 and year-to-date period ended September 28, 2013		6

Consolidated Statement of Cash Flows — year-to-date periods ended September 28, 2013 and September 29, 2012		7

Notes to Consolidated Financial Statements		8

Item 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations		26

Item 3:
Quantitative and Qualitative Disclosures about Market Risk		40

Item 4:
Controls and Procedures		40

PART II — Other Information

Item 1A:
Risk Factors		41

Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds		42

Item 6:
Exhibits		42

Signatures		43

Exhibit Index		44

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED BALANCE SHEET

(millions, except per share data)


	September 28, 2013 (unaudited)			December 29, 2012 *
Current assets
Cash and cash equivalents	$	300		$	281
Accounts receivable, net		1,474			1,454
Inventories:
Raw materials and supplies		331			300
Finished goods and materials in process		981			1,065
Deferred income taxes		185			152
Other prepaid assets		163			128

Total current assets		3,434			3,380

Property, net of accumulated depreciation of $5,387 and $5,209		3,777			3,782
Goodwill **		5,052			5,038
Other intangibles, net of accumulated amortization of $59 and $53		2,364			2,359
Pension		187			145
Other assets		406			465


Total assets	$	15,220		$	15,169



Current liabilities
Current maturities of long-term debt	$	298		$	755
Notes payable		756			1,065
Accounts payable		1,399			1,402
Accrued advertising and promotion		512			517
Accrued income taxes		75			46
Accrued salaries and wages		257			266
Other current liabilities		537			472


Total current liabilities		3,834			4,523

Long-term debt		6,348			6,082
Deferred income taxes		560			523
Pension liability		886			886
Nonpension postretirement benefits		271			281
Other liabilities		425			409

Commitments and contingencies

Equity
Common stock, $.25 par value		105			105
Capital in excess of par value		620			573
Retained earnings		6,098			5,615
Treasury stock, at cost		(3,025	)		(2,943	)
Accumulated other comprehensive income (loss) **		(963	)		(946	)


Total Kellogg Company equity		2,835			2,404

Noncontrolling interests		61			61

Total equity		2,896			2,465

Total liabilities and equity	$	15,220		$	15,169

*	Condensed from audited financial statements.

**	December 29, 2012 balances 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
	September 28,			September 29,			September 28,			September 29,
(Results are unaudited)	2013			2012			2013			2012
Net sales	$	3,716		$	3,720		$	11,291		$	10,634

Cost of goods sold		2,266			2,254			6,971			6,376
Selling, general and administrative expense		946			953			2,743			2,699


Operating profit		504			513			1,577			1,559

Interest expense		56			73			177			195
Other income (expense), net		4			10			(8	)		30


Income before income taxes		452			450			1,392			1,394
Income taxes		124			131			398			400
Earnings (loss) from joint ventures		(2	)		(1	)		(5	)		(1	)

Net income	$	326		$	318		$	989		$	993

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

Net income attributable to Kellogg Company	$	326		$	318		$	989		$	993



Per share amounts:
Basic	$	0.90		$	0.89		$	2.72		$	2.78
Diluted	$	0.90		$	0.89		$	2.70		$	2.77

Dividends per share	$	0.460		$	0.440		$	1.340		$	1.300


Average shares outstanding:
Basic		362			358			363			357

Diluted		364			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 September 28, 2013						Year-to-date period ended September 28, 2013
(Results are unaudited)	Pre-tax amount		Tax (expense) benefit		After-tax amount		Pre-tax amount		Tax (expense) benefit		After-tax amount

Net income					$	326					$	989
Other comprehensive income (loss):
Foreign currency translation adjustments*	$	63	$	—		63	$	(28)	$	—		(28)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		(7)		3		(4)		5		—		5
Reclassification to net income		(2)		—		(2)		(4)		—		(4)
Postretirement and postemployment benefits:
Net experience gain (loss)		—		—		—		—		—		—
Prior service credit (cost)		(1)		—		(1)		(1)		—		(1)
Reclassification to net income:
Net experience loss		1		—		1		4		—		4
Prior service cost		4		(1)		3		10		(3)		7

Other comprehensive income (loss)	$	58	$	2	$	60	$	(14)	$	(3)	$	(17)

Comprehensive income					$	386					$	972



	Quarter ended September 29, 2012						Year-to-date period ended September 29, 2012
(Results are unaudited)	Pre-tax amount		Tax (expense) benefit		After-tax amount		Pre-tax amount		Tax (expense) benefit		After-tax amount

Net income					$	318					$	993
Other comprehensive income (loss):
Foreign currency translation adjustments*	$	101	$	—		101	$	75	$	2		77
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		(1)		—		(1)		(9)		3		(6)
Reclassification to net income		3		(1)		2		12		(4)		8
Postretirement and postemployment benefits:
Amounts arising during the period:
Net experience gain (loss)*		—		—		—		(3)		1		(2)
Prior service credit (cost)*		—		—		—		(10)		3		(7)
Reclassification to net income:
Net experience loss*		2		—		2		4		—		4
Prior service cost*		2		(1)		1		9		(3)		6

Other comprehensive income (loss)	$	107	$	(2)	$	105	$	78	$	2	$	80

Comprehensive income					$	423					$	1,073

* December 29, 2012 balances 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											9		(544	)					(544	)				(544	)
Net income								989											989					989			989
Dividends								(486	)										(486	)				(486	)
Other comprehensive loss*																(17	)		(17	)				(17	)		(17	)
Stock compensation						24													24					24
Stock options exercised and other						23		(20)			(9)		462						465					465
Balance, September 28, 2013		420	$	105	$	620	$	6,098			58	$	(3,025	)	$	(963	)	$	2,835		$	61	$	2,896		$	972

*	December 29, 2012 balances 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 CASH FLOWS

(millions)


	Year-to-date period ended
	September 28,			September 29,
(unaudited)	2013			2012
Operating activities
Net income	$	989		$	993
Adjustments to reconcile net income to operating cash flows:
Depreciation and amortization		340			302
Postretirement benefit plan expense (benefit)		(10	)		(14	)
Deferred income taxes		(27	)		(20	)
Other		73			(29	)
Postretirement benefit plan contributions		(42	)		(43	)
Changes in operating assets and liabilities, net of acquisitions:
Trade receivables		(113	)		(95	)
Inventories		52			(5	)
Accounts payable		(2	)		145
Accrued income taxes		52			1
Accrued interest expense		33			43
Accrued and prepaid advertising, promotion and trade allowances		(4	)		118
Accrued salaries and wages		(9	)		—
All other current assets and liabilities		57			(21	)


Net cash provided by (used in) operating activities		1,389			1,375


Investing activities
Additions to properties		(363	)		(262	)
Acquisitions, net of cash acquired		—			(2,674	)
Other		(1	)		8


Net cash provided by (used in) investing activities		(364	)		(2,928	)


Financing activities
Net issuances (reductions) of notes payable		(309	)		112
Issuances of long-term debt		645			1,727
Reductions of long-term debt		(761	)		—
Net issuances of common stock		450			87
Common stock repurchases		(544	)		(63	)
Cash dividends		(486	)		(464	)
Other		23			(2	)


Net cash provided by (used in) financing activities		(982	)		1,397


Effect of exchange rate changes on cash and cash equivalents		(24	)		1


Increase (decrease) in cash and cash equivalents		19			(155	)
Cash and cash equivalents at beginning of period		281			460


Cash and cash equivalents at end of period	$	300		$	305

Refer to Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements

for the quarter ended September 28, 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 September 28, 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 December 29, 2012 and September 28, 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 quarter ended June 29, 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 were 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 as of December 29, 2012 and no impact for the year-to-date period ended September 29, 2012.

During the quarter ended September 28, 2013, the Company recorded an immaterial correction of an error to the purchase price allocation for Pringles that was outside of the measurement period, which resulted in an increase to other non-current liabilities, goodwill and non-current deferred tax assets of $15 million, $13 million and $2 million, respectively. The goodwill of $13 million was allocated to our operating segments as follows: Europe, $10 million and Asia Pacific, $3 million.

As part of the Pringles acquisition, we incurred $12 million of integration-related costs in the third quarter of 2013 of which $7 million are recorded in selling, general and administrative (SGA) expense, $3 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 September 28, 2013 were $48 million of which $34 million are recorded in SGA expense, $9 million are recorded in COGS and $5 million are recorded in net sales.

Pringles contributed net revenues of $422 million and net earnings of $49 million for the third quarter of 2013 and contributed net revenues of $1,216 million and net earnings of $97 million for the year-to-date period ended September 28, 2013, including the integration-related costs discussed above. The unaudited pro forma combined historical third 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 September 29, 2012		Year-to-date period ended September 29, 2012
Net sales	$	3,720	$	11,299


Net income	$	318	$	1,041
Net income (loss) attributable to noncontrolling interests		—		—

Net income attributable to Kellogg Company	$	318	$	1,041


Net earnings per share	$	0.89	$	2.90

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 2011, nor are they necessarily indicative of future consolidated results.

Changes in the carrying amount of goodwill for the year-to-date period ended September 28, 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		—		—			10		—			3			24
Currency translation adjustment		—		—		—		(1	)		1		(2	)		(8	)		(10	)
September 28, 2013	$	133	$	3,778	$	82	$	279		$	449	$	90		$	241		$	5,052

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		—		—			—		—		—			—		—			—

September 28, 2013	$	28	$	70		$	—	$	5	$	43		$	7	$	10		$	163



Accumulated Amortization

December 29, 2012	$	28	$	12		$	—	$	3	$	3		$	7	$	—		$	53
Amortization		—		3			—		—		2			—		1			6
September 28, 2013	$	28	$	15		$	—	$	3	$	5		$	7	$	1		$	59



Intangible assets subject to amortization, net

December 29, 2012	$	—	$	58		$	—	$	2	$	40		$	—	$	10		$	110
Currency translation adjustment		—		—			—		—		—			—		—			—
Amortization		—		(3	)		—		—		(2	)		—		(1	)		(6	)

September 28, 2013	$	—	$	55		$	—	$	2	$	38		$	—	$	9		$	104

For intangible assets in the preceding table, amortization was $6 million for the current year-to-date period ended September 28, 2013, compared to $1 million for the prior year-to-date period ended September 29, 2012. The currently estimated aggregate annual amortization expense for full-year 2013 and each of the four succeeding fiscal years is approximately $9 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		—		—		—		—		11		—		—		11
September 28, 2013	$	63	$	1,625	$	—	$	95	$	477	$	—	$	—	$	2,260

Note 3 Exit or disposal activities

The Company views its continued spending on cost-reduction initiatives as part of its on-going operating principles to provide greater visibility in achieving 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 is expected to deliver cash savings and/or reduced depreciation.

Costs summary

On-going initiatives

Prior to the beginning of the quarter ended September 28, 2013, the Company had commenced various COGS and SGA initiatives. The COGS initiatives are intended to optimize the Company’s global manufacturing network, reduce waste, and develop best practices on a global basis. The SGA initiatives focus on improvements in the efficiency and effectiveness of various global support functions. These initiatives are expected to be substantially complete by the end of 2013.

During the quarter ended September 28, 2013, the Company recorded a $1 million reduction in expense resulting from adjustments to severance reserves related to one of these on-going initiatives which impacted the U.S. Morning Foods reportable segment. During the year-to-date period ended September 28, 2013, the Company recorded $9 million of charges associated with exit or disposal activities for on-going initiatives. The tables below provide the details for the charges incurred for currently active on-going initiatives during the quarter and year-to-date periods ended September 28, 2013 and September 29, 2012:


	Quarter ended							Year-to-date period ended						Program costs to date
(millions)	September 28, 2013				September 29, 2012			September 28, 2013			September 29, 2012			September 28, 2013
Employee related costs		$	(1	)		$	—		$	3		$	3		$	6
Asset related costs			—				1			4			2			21
Other costs			—				—			2			—			2

Total		$	(1	)		$	1		$	9		$	5		$	29


	Quarter ended							Year-to-date period ended						Program costs to date
(millions)	September 28, 2013				September 29, 2012			September 28, 2013			September 29, 2012			September 28, 2013
U.S. Morning Foods		$	(1	)		$	—		$	2		$	1		$	3
U.S. Snacks			—				1			1			3			3
Europe			—				—			—			1			—
Asia Pacific			—				—			6			—			23

Total		$	(1	)		$	1		$	9		$	5		$	29

Other costs include incremental charges for equipment removal and relocation of assets and employees that are directly related to exit or disposal activities.

At September 28, 2013, there were no exit cost reserves for severance for these initiatives. Based on forecasted exchange rates, the Company currently expects to incur an additional $2 million in exit costs for these initiatives in 2013.

New initiatives

Europe Supply Chain

During the quarter ended September 28, 2013, the Company commenced two new initiatives that are designed to improve operational effectiveness in Europe. Total costs for these initiatives are expected to be $6 million, consisting primarily of severance costs and asset write-offs. The Company recorded a charge of $2 million associated with exit or disposal activities for these initiatives which consisted primarily of severance costs. At September 28, 2013 exit cost reserves for severance for these initiatives were $2 million. Based on forecasted exchange rates, the Company currently expects to incur an additional $4 million in exit costs for these initiatives in 2013. These initiatives are expected to be substantially complete by the end of 2013.

Project K

On November 4, 2013, the Company announced Project K, a global four-year efficiency and effectiveness program. The program is expected to generate a significant amount of savings, once all phases are approved and implemented, that will be invested in key strategic areas of focus for the business. The Company expects that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow.

The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories.

The Company currently anticipates that the program will result in total pre-tax charges, once all phases are approved and implemented, of $1.2 to $1.4 billion, with cash costs estimated to be $900 million to $1.1 billion. The Company currently expects the charges will consist of asset-related costs totaling $450 to $500 million which will consist primarily of asset impairments and other exit-related costs; employee-related costs totaling $425 to $475 million which will include severance, pension and other termination benefits; and other costs totaling $325 to $425 million which will consist primarily of charges related to the design and implementation of global business capabilities. A significant portion of other costs are the result of the implementation of global business service centers which are intended to simplify and standardize business support processes.

The Company currently expects that total pre-tax charges will impact reportable segments as follows: U.S. Morning Foods (approximately 18%), U.S. Snacks (approximately 10%), U.S. Specialty (approximately 2%) North America Other (approximately 3%), Europe (approximately 8%), Latin America (approximately 5%), Asia-Pacific (approximately 7%), and Corporate (approximately 47%). A majority of the costs impacting Corporate relate to additional initiatives to be executed after 2014 that are currently not fully defined. As the development of these initiatives is completed, the Company will update its estimated costs by reportable segment as needed.

In the third quarter, the Company recognized charges of $17 million that have been attributed to the program. The tables below outline the details of these charges:

Project K


	Quarter ended		Year-to-date period ended
(millions)	September 28, 2013		September 28, 2013
Employee related costs	$	8	$	8
Asset related costs		—		—
Other costs		9		9

Total	$	17	$	17



	Quarter ended		Year-to-date period ended
(millions)	September 28, 2013		September 28, 2013
U.S. Morning Foods	$	5	$	5
U.S. Snacks		1		1
U.S. Specialty		1		1
Latin America		3		3
Asia Pacific		1		1
Center		6		6

Total	$	17	$	17

Other costs incurred during the quarter ended September 28, 2013 consist primarily of third-party incremental costs related to the development and implementation of global business capabilities.

At September 28, 2013 exit cost reserves for Project K were $6 million. The following table provides details for Project K exit cost reserves.


(millions)	Balance December 29, 2012		Costs Incurred		Cash Payments			Balance September 28, 2013
Project K	$	—	$	17	$	(11	)	$	6

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 anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended September 28, 2013 of 6 million and 5 million, respectively. The total number of anti-dilutive potential common shares excluded from the reconciliation were 16 million and 17 million, respectively, for the quarter and year-to-date periods ended September 29, 2012.

Quarters ended September 28, 2013 and September 29, 2012:

(millions, except per share data)

Net income
attributable to
Kellogg Company*

Average
shares
outstanding

Earnings
per share*

2013

Basic

$326

362

$0.90

Dilutive potential common shares

—

Diluted

$326

364

$0.90

2012

Basic

$318

358

$0.89

Dilutive potential common shares

—

Diluted

$318

359

$0.89

*	2012 amounts have been revised as discussed in Note 7 to the financial statements.

Year-to-date periods ended September 28, 2013 and September 29, 2012:

(millions, except per share data)

Net income
attributable to
Kellogg Company*

Average
shares
outstanding

Earnings
per share*

2013

Basic

$989

363

$2.72

Dilutive potential common shares

(0.02)

Diluted

$989

366

$2.70

2012

Basic

$993

357

$2.78

Dilutive potential common shares

(0.01)

Diluted

$993

359

$2.77

*	2012 amounts have been revised as discussed in Note 7 to the financial statements.

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 extended through August 2013. During the second quarter of 2013, 4.9 million shares were initially delivered to the Company and accounted for as a reduction to Kellogg Company equity. The transaction was completed during the third quarter, at which time the Company received 0.6 million additional shares. The total number of shares delivered upon settlement of the ASR was based upon the volume weighted average price of the Company’s stock over the term of the agreement.

During the year-to-date period ended September 28, 2013, the Company repurchased approximately 9 million shares of common stock for a total of $544 million, including shares delivered under the ASR. During the year-to-date period ended September 29, 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 September 28, 2013									Year-to-date period ended September 28, 2013
(millions)	Pre-tax amount			Tax (expense) or benefit			After-tax amount			Pre-tax amount			Tax (expense) or benefit			After-tax amount
Net income							$	326								$	989
Other comprehensive income (loss):
Foreign currency translation adjustments	$	63		$	—			63		$	(28	)	$	—			(28	)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		(7	)		3			(4	)		5			—			5
Reclassification to net earnings		(2	)		—			(2	)		(4	)		—			(4	)
Postretirement and postemployment benefits:
Amounts arising during the period:
Net experience gain (loss)		—			—			—			—			—			—
Prior service credit (cost)		(1	)		—			(1	)		(1	)		—			(1	)
Reclassification to net income:
Net experience loss		1			—			1			4			—			4
Prior service cost		4			(1	)		3			10			(3	)		7

Other comprehensive income (loss)	$	58		$	2			60		$	(14	)	$	(3	)		(17	)

Comprehensive income							$	386								$	972

Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended September 28, 2013 consisted of the following:


(millions)
Details about AOCI components	Amount reclassified from AOCI		Line item impacted within Income Statement
	Quarter ended September 28, 2013	Year-to-date period ended September 28, 2013
Gains and losses on cash flow hedges:
Foreign currency exchange contracts	$ (2)	$ (7)	COGS
Foreign currency exchange contracts	(1)	(1)	SGA
Interest rate contracts	(1)	(3)	Interest expense
Commodity contracts	2	7	COGS

	$ (2)	$ (4)	Total before tax
	—	—	Tax (expense) benefit

	$ (2)	$ (4)	Net of tax

Amortization of postretirement and postemployment benefits:
Net experience loss	$ 1	$ 4	See Note 7 for further details
Prior service cost	4	10	See Note 7 for further details

	$ 5	$ 14	Total before tax
	(1)	(3)	Tax (expense) benefit

	$ 4	$ 11	Net of tax

Total reclassifications	$ 2	$ 7	Net of tax

Accumulated other comprehensive income (loss) as of September 28, 2013 and December 29, 2012 consisted of the following:


	September 28,		December 29,
(millions)	2013		2012
Foreign currency translation adjustments	$	(860)		$ (832)
Cash flow hedges — unrealized net gain (loss)		(2)		(3)
Postretirement and postemployment benefits:
Net experience loss		(25)		(29)
Prior service cost		(76)		(82)

Total accumulated other comprehensive income (loss)	$	(963)		$ (946)

Note 5 Debt

The following table presents the components of notes payable at September 28, 2013 and December 29, 2012:

September 28, 2013

December 29, 2012

(millions)

Principal
amount

Effective
interest rate

Principal
amount

Effective
interest rate

U.S. commercial paper

$573

0.21

$853

0.26

Europe commercial paper

142

0.20

159

0.18

Bank borrowings

Total

$756

$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. These derivative instruments were designated as fair value hedges. The effective interest rates on debt obligations resulting from the Company’s interest rate swaps as of September 28, 2013 were as follows: (a) seven-year 4.45% U.S. Dollar Notes due 2016 – 3.46%; (b) five-year 1.875% U.S. Dollar Notes due 2016 – 1.01%; (c) five-year 1.75% U.S. Dollar Notes due 2017—1.35%; (d) seven-year 3.25% U.S. Dollar Notes due 2018 – 1.89%; (e) ten-year 4.15% U.S. Dollar Notes due 2019—2.74%; (f) ten-year 4.00% U.S. Dollar Notes due 2020—2.91%; (g) ten-year 3.125% U.S. Dollar Notes due 2022—2.74%.

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)	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Pre-tax compensation expense		$	10		$	10		$	31		$	32

Related income tax benefit		$	4		$	4		$	12		$	12

As of September 28, 2013, total stock-based compensation cost related to non-vested awards not yet recognized was $56 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 September 28, 2013 and September 29, 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 September 28, 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

(10)

Forfeitures and expirations

(1)

Outstanding, end of period

$53

7.2

$111

Exercisable, end of period

$50

5.5

$88

Year-to-date period ended September 29, 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			52
Exercised		(2	)		43
Forfeitures and expirations		(1	)		53
Outstanding, end of period		27			$49		6.4		$78
Exercisable, end of period		17			$48		5.1		$78

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 September 28, 2013 and September 29, 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 September 28, 2013:		15	%		7.44		1.49	%		2.90	%
Grants within the year-to-date period ended September 29, 2012:		16	%		7.53		1.60	%		3.30	%

The total intrinsic value of options exercised was $133 million and $16 million for the year-to-date periods ended September 28, 2013 and September 29, 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 210,000 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 September 28, 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)		September 28, 2013
2011 Award		$22
2012 Award		$22
2013 Award		$25

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. Prior year amounts have been revised to reflect the new policy.

Pension


	Quarter ended				Year-to-date period ended
(millions)	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Service cost		$ 33		$ 28		$ 101		$ 82
Interest cost		51		53		151		156
Expected return on plan assets		(90)		(86)		(269)		(257)
Amortization of unrecognized prior service cost		4		3		12		10

Total pension expense (income)		$ (2)		$ (2)		$ (5)		$ (9)

Other nonpension postretirement


	Quarter ended				Year-to-date period ended
(millions)	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Service cost		$ 8		$ 7		$ 25		$ 20
Interest cost		13		13		37		39
Expected return on plan assets		(21)		(21)		(65)		(63)
Amortization of unrecognized prior service cost		—		(1)		(2)		(1)

Total postretirement benefit expense (income)		$ —		$ (2)		$ (5)		$ (5)

Postemployment


	Quarter ended				Year-to-date period ended
(millions)	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Service cost		$ 2		$ 2		$ 5		$ 6
Interest cost		1		1		3		3
Recognized net loss		1		1		4		3

Total postemployment benefit expense		$ 4		$ 4		$ 12		$ 12

Company contributions to employee benefit plans are summarized as follows:


			Nonpension
(millions)	Pension		postretirement		Total
Quarter ended:
September 28, 2013	$	2	$	4	$	6
September 29, 2012	$	7	$	3	$	10

Year-to-date period ended:
September 28, 2013	$	30	$	12	$	42
September 29, 2012	$	31	$	12	$	43

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 September 28, 2013 was 27% as compared to the prior year’s rate of 29%. The lower effective rate in the current quarter was primarily due to a rate reduction and the elimination of a tax liability in international jurisdictions. The consolidated effective tax rate for the year-to-date periods ended September 28, 2013 and September 29, 2012 was 29%.

As of September 28, 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 $10 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 September 28, 2013; $60 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			8
Reductions			—
Tax positions related to prior years:
Additions			11
Reductions			(5)
Settlements			(11)
September 28, 2013			$ 83

For the year-to-date period ended September 28, 2013, the Company recognized expense of $4 million for tax-related interest and cash settlements of $5 million, resulting in an accrual balance of $18 million at September 28, 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 September 28, 2013 and December 29, 2012 were as follows:


	September 28,		December 29,
(millions)	2013		2012
Foreign currency exchange contracts		$ 645		$ 570
Interest rate contracts		2,400		2,150
Commodity contracts		383		320

Total		$3,428		$ 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 September 28, 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 September 28, 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 September 28, 2013 and December 29, 2012:

Derivatives designated as hedging instruments


	September 28, 2013						December 29, 2012
(millions)	Level 1		Level 2		Total		Level 1		Level 2		Total
Assets:
Foreign currency exchange contracts:
Other prepaid assets		$—		$ 4		$ 4		$—		$ 4		$ 4
Interest rate contracts (a):
Other assets		—		—		—		—		64		64

Total assets		$—		$ 4		$ 4		$—		$ 68		$ 68

Liabilities:
Foreign currency exchange contracts:
Other current liabilities		$—		$ (8)		$ (8)		$—		$ (3)		$ (3)
Interest rate contracts:
Other liabilities		—		(43)		(43)		—		—		—
Commodity contracts:
Other current liabilities		—		(10)		(10)		—		(11)		(11)
Other liabilities		—		(21)		(21)		—		(27)		(27)

Total liabilities		$—		$ (82)		$ (82)		$—		$ (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 September 28, 2013 and $2.3 billion as of December 29, 2012.

Derivatives not designated as hedging instruments

September 28, 2013

December 29, 2012

(millions)

Level 1

Level 2

Total

Level 1

Level 2

Total

Assets:

Foreign currency exchange contracts:

Other prepaid assets

$ —

$ 1

$ —

$—

$ —

Commodity contracts:

Other prepaid assets

—

Total assets

$ 5

$ 1

$ 6

$ 5

$—

$ 5

Liabilities:

Foreign currency exchange contracts:

Other current liabilities

$ —

$ (1)

$ —

$—

$ —

Commodity contracts:

Other current liabilities

(9)

—

(9)

(3)

—

(3)

Total liabilities

$ (9)

$ (1)

$ (10)

$ (3)

$—

$ (3)

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the quarters ended September 28, 2013 and September 29, 2012 was as follows:

Derivatives in fair value hedging relationships


	Location of gain (loss)	Gain (loss)
(millions)	recognized in income	recognized in income (a)
		Sep. 28,			Sep. 29,
		2013			2012
Foreign currency exchange contracts	Other income (expense), net	$	(1	)	$	2
Interest rate contracts	Interest expense		(3	)		4
Total		$	(4	)	$	6

(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)
	Sep. 28,			Sep. 29,				Sep. 28,			Sep. 29,				Sep. 28,		Sep. 29,
	2013			2012				2013			2012				2013		2012
Foreign currency exchange contracts	$	(4	)	$	(4	)	COGS	$	2		$	(1	)	Other income (expense), net	$	—	$	—
Foreign currency exchange contracts		(3	)		—		SGA expense		1			1		Other income (expense), net		—		—
Interest rate contracts		—			—		Interest expense		1			1		N/A		—		—
Commodity contracts		—			3		COGS		(2	)		(4	)	Other income (expense), net		—		—

Total	$	(7	)	$	(1	)		$	2		$	(3	)		$	—	$	—

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

Derivatives in net investment hedging relationships


	Gain (loss)
	recognized in
(millions)	AOCI
	Sep. 28,		Sep. 29,
	2013		2012
Foreign currency exchange contracts	$	—	$	(1	)

Total	$	—	$	(1	)

Derivatives not designated as hedging instruments


(millions)	Location of gain (loss) recognized in income			Gain (loss) recognized in income
				Sep. 28,			Sep. 29,
				2013			2012
Foreign currency exchange contracts		Other income	(expense), net	$	1		$	—
Commodity contracts		COGS			(2	)		(3	)

Total				$	(1	)	$	(3	)

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the year-to-date periods ended September 28, 2013 and September 29, 2012 were as follows:

Derivatives in fair value hedging relationships


	Location of gain (loss)	Gain (loss)
(millions)	recognized in income	recognized in income(a)
		Sep. 28,			Sep. 29,
		2013			2012
Foreign currency exchange contracts	Other income (expense), net	$	2		$	1
Interest rate contracts	Interest expense		(2	)		4

Total		$	—		$	5

(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)
	Sep. 28,			Sep. 29,				Sep. 28,			Sep. 29,				Sep. 28,		Sep. 29,
	2013			2012				2013			2012				2013		2012
Foreign currency exchange contracts	$	8		$	(5	)	COGS	$	7		$	(1	)	Other income (expense), net	$	—	$	—
Foreign currency exchange contracts		(2	)		1		SGA expense		1			2		Other income (expense), net		—		—
Interest rate contracts		—			—		Interest expense		3			3		N/A		—		—
Commodity contracts		(1	)		(5	)	COGS		(7	)		(16	)	Other income (expense), net		—		—

Total	$	5		$	(9	)		$	4		$	(12	)		$	—	$	—

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

Derivatives in net investment hedging relationships


	Gain (loss)
	recognized in
(millions)	AOCI
	Sep. 28,		Sep. 29,
	2013		2012
Foreign currency exchange contracts	$	—	$	5

Total	$	—	$	5

Derivatives not designated as hedging instruments


	Location of gain (loss)	Gain (loss)
(millions)	recognized in income	recognized in income
		Sep. 28,			Sep. 29,
		2013			2012
Foreign currency exchange contracts	COGS	$	2		$	—
Interest rate contracts	Interest expense		—			(1	)
Commodity contracts	COGS		(26	)		(3	)

Total		$	(24	)	$	(4	)

During the next 12 months, the Company expects $8.0 million of net deferred losses reported in AOCI at September 28, 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 September 28, 2013 was $59 million. If the credit-risk-related contingent features were triggered as of September 28, 2013, the Company would be required to post additional collateral of $54 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 September 28, 2013 triggered by credit-risk-related contingent features, however, there was $5 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 September 28, 2013:


(millions)	Fair Value		Carrying Value
Current maturities of long-term debt	$	298	$	298
Long-term debt		6,794		6,348

Total	$	7,092	$	6,646

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 September 28, 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 September 28, 2013 the Company had posted collateral of $5 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 27% of consolidated trade receivables at September 28, 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)	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Net sales
U.S. Morning Foods	$	883		$	903		$	2,657		$	2,692
U.S. Snacks		886			908			2,704			2,544
U.S. Specialty		281			264			932			864
North America Other		382			388			1,173			1,125
Europe		729			685			2,144			1,836
Latin America		302			292			914			836
Asia Pacific		253			280			767			737

Consolidated	$	3,716		$	3,720		$	11,291		$	10,634
Operating profit
U.S. Morning Foods	$	132		$	134		$	475		$	465
U.S. Snacks		105			117			341			361
U.S. Specialty		70			62			210			189
North America Other		70			67			223			207
Europe		74			76			220			210
Latin America		39			36			129			135
Asia Pacific		25			29			63			79

Total Reportable Segments		515			521			1,661			1,646
Corporate		(11	)		(8	)		(84	)		(87	)
Consolidated	$	504		$	513		$	1,577		$	1,559

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.

On November 4, 2013, we announced Project K, a global four-year efficiency and effectiveness program. The program is expected to generate a significant amount of savings, once all phases are approved and implemented, that will be invested in key strategic areas of focus for the business. We expect that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow. See the Exit or disposal activities section for more information.

Comparability of certain financial measures is impacted significantly by two types of charges: 1) Mark-to-market adjustments that are recorded for pensions and commodity derivative contracts; and 2) Charges related to Project K. 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 these charges. 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 following impacts, if applicable: foreign currency translation, mark-to-market adjustments, acquisitions, dispositions, integration costs associated with the acquisition of the Pringles business, and charges related to Project K.

For the quarter ended September 28, 2013, our reported net sales declined slightly while internal net sales increased by 0.5%. We experienced solid increases in internal net sales in Europe, Latin America and Asia-Pacific, while internal net sales in U.S. Morning Foods and U.S. Snacks declined. Reported operating profit declined by 2%, and underlying internal operating profit increased by 1%. This result includes the impact of cost containment in overhead and consumer promotion investments which was partially offset by increased advertising investment and the anticipated negative impact of inflation, net of cost savings.

Diluted EPS of $.90 for the quarter was up 1% compared to prior year diluted EPS of $.89. Underlying diluted EPS for the quarter of $.93 was up 4% compared to the prior year underlying diluted EPS of $.89, ahead of our expectations due to better than expected cost containment and a lower tax rate.

Reconciliation of certain non-GAAP Financial Measures


	Quarter ended						Year-to-date period ended

Consolidated results (dollars in millions, except per share data)	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012

Reported operating profit	$	504		$	513		$	1,577		$	1,559
Mark-to-market (a)		2			—			(59	)		(50	)
Project K (b)		(17	)		—			(17	)		—

Underlying operating profit (c), (d)	$	519		$	513		$	1,653		$	1,609

Reported income taxes	$	124		$	131		$	398		$	400
Mark-to-market (a)		—			—			(19	)		(15	)
Project K (b)		(5	)		—			(5	)		—

Underlying income taxes (c)	$	129		$	131		$	422		$	415

Reported net income attributable to Kellogg Company	$	326		$	318		$	989		$	993
Mark-to-market (a)		2			—			(40	)		(35	)
Project K (b)		(12	)		—			(12	)		—

Underlying net income attributable to Kellogg Company (c), (d)	$	336		$	318		$	1,041		$	1,028

Reported basic EPS	$	0.90		$	0.89		$	2.72		$	2.78
Mark-to-market (a)		—			—			(0.12	)		(0.10	)
Project K (b)		(0.03	)		—			(0.03	)		—

Underlying basic EPS (c)	$	0.93		$	0.89		$	2.87		$	2.88
Underlying basic EPS growth (c)		4.5	%		4.7	%		(0.3	)%		(2.0	)%

Reported diluted EPS	$	0.90		$	0.89		$	2.70		$	2.77
Mark-to-market (a)		—			—			(0.12	)		(0.10	)
Project K (b)		(0.03	)		—			(0.03	)		—

Underlying diluted EPS (c)	$	0.93		$	0.89		$	2.85		$	2.87
Underlying diluted EPS growth (c)		4.5	%		6.0	%		(0.7	)%		(1.4	)%

(a)

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 and third quarters of 2013 and 2012, 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.

(b)

Costs incurred attributed to Project K, a global four-year efficiency and effectiveness program. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories.

(c)

Underlying operating profit, 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 and Project K. 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.

(d)

Underlying operating profit for the quarters ended September 28, 2013 and September 29, 2012 includes postretirement benefit plan income of $2 million and $4 million, respectively. Underlying operating profit for the year-to-date periods ended September 28, 2013 and September 29, 2012 includes postretirement benefit plan income of $10 million and $14 million, respectively.

Underlying net income attributable to Kellogg Company for the quarters ended September 28, 2013 and September 29, 2012 includes postretirement benefit plan income of $2 million and $3 million, respectively. Underlying net income attributable to Kellogg Company for the year-to-date periods ended September 28, 2013 and September 29, 2012 includes postretirement benefit plan income of $7 million and $10 million, respectively.

Net sales and operating profit

The following table provides an analysis of net sales and operating profit performance for the third 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			Corp- orate			Consol- idated
2013 net sales	$	883		$	886		$	281		$	382		$	729		$	302		$	253		$	—		$	3,716

2012 net sales	$	903		$	908		$	264		$	388		$	685		$	292		$	280		$	—		$	3,720

% change—2013 vs. 2012:
As reported		(2.2	)%		(2.5	)%		6.2	%		(1.5	)%		6.4	%		3.4	%		(9.4	)%		—	%		(.1	)%
Acquisitions/Divestitures		—	%		.8	%		—	%		—	%		—	%		—	%		(1.4	)%		—	%		—	%
Integration (a)		—	%		—	%		—	%		—	%		—	%		—	%		(.6	)%		—	%		—	%
Foreign currency impact		—	%		—	%		—	%		(1.8	)%		3.1	%		(3.3	)%		(10.3	)%		—	%		(.6	)%
Internal business (b)		(2.2	)%		(3.3	)%		6.2	%		.3	%		3.3	%		6.7	%		2.9	%		—	%		.5	%



(dollars in millions)	U.S. Morning Foods			U.S. Snacks			U.S. Specialty			North America Other			Europe			Latin America			Asia Pacific			Corp- orate			Consol- idated

2013 operating profit	$	132		$	105		$	70		$	70		$	74		$	39		$	25		$	(11	)	$	504


2012 operating profit	$	134		$	117		$	62		$	67		$	76		$	36		$	29		$	(8

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