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)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended April 2, 2016
OR
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¨ | 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
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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.
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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 April 30, 2016 — 350,048,199 shares
KELLOGG COMPANY
INDEX
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Financial Statements | |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations | |
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Quantitative and Qualitative Disclosures about Market Risk | |
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Controls and Procedures | |
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Risk Factors | |
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Unregistered Sales of Equity Securities and Use of Proceeds | |
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Exhibits | |
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Part I – FINANCIAL INFORMATION
Item 1. Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED BALANCE SHEET
(millions, except per share data)
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| | | | | | |
| April 2, 2016 (unaudited) | January 2, 2016 * |
Current assets | | |
Cash and cash equivalents | $ | 310 |
| $ | 251 |
|
Accounts receivable, net | 1,505 |
| 1,344 |
|
Inventories: | | |
Raw materials and supplies | 330 |
| 315 |
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Finished goods and materials in process | 868 |
| 935 |
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Deferred income taxes | — |
| 227 |
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Other prepaid assets | 206 |
| 164 |
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Total current assets | 3,219 |
| 3,236 |
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Property, net of accumulated depreciation of $5,263 and $5,236 | 3,617 |
| 3,621 |
|
Investments in unconsolidated entities | 465 |
| 456 |
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Goodwill | 4,974 |
| 4,968 |
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Other intangibles, net of accumulated amortization of $49 and $47 | 2,293 |
| 2,268 |
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Pension | 248 |
| 231 |
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Other assets | 481 |
| 471 |
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Total assets | $ | 15,297 |
| $ | 15,251 |
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Current liabilities | | |
Current maturities of long-term debt | $ | 1,264 |
| $ | 1,266 |
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Notes payable | 718 |
| 1,204 |
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Accounts payable | 1,926 |
| 1,907 |
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Accrued advertising and promotion | 465 |
| 447 |
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Accrued income taxes | 19 |
| 42 |
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Accrued salaries and wages | 212 |
| 325 |
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Other current liabilities | 558 |
| 548 |
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Total current liabilities | 5,162 |
| 5,739 |
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Long-term debt | 6,256 |
| 5,275 |
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Deferred income taxes | 447 |
| 685 |
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Pension liability | 937 |
| 946 |
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Nonpension postretirement benefits | 70 |
| 77 |
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Other liabilities | 384 |
| 391 |
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Commitments and contingencies |
|
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Equity | | |
Common stock, $.25 par value | 105 |
| 105 |
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Capital in excess of par value | 754 |
| 745 |
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Retained earnings | 6,595 |
| 6,597 |
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Treasury stock, at cost | (3,989 | ) | (3,943 | ) |
Accumulated other comprehensive income (loss) | (1,434 | ) | (1,376 | ) |
Total Kellogg Company equity | 2,031 |
| 2,128 |
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Noncontrolling interests | 10 |
| 10 |
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Total equity | 2,041 |
| 2,138 |
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Total liabilities and equity | $ | 15,297 |
| $ | 15,251 |
|
* Condensed from audited financial statements.
Refer to Notes to Consolidated Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF INCOME
(millions, except per share data)
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| | | | | | |
| Quarter ended |
(Results are unaudited) | April 2, 2016 | April 4, 2015 |
Net sales | $ | 3,395 |
| $ | 3,556 |
|
Cost of goods sold | 2,150 |
| 2,311 |
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Selling, general and administrative expense | 807 |
| 861 |
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Operating profit | 438 |
| 384 |
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Interest expense | 217 |
| 54 |
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Other income (expense), net | — |
| (26 | ) |
Income before income taxes | 221 |
| 304 |
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Income taxes | 47 |
| 76 |
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Earnings (loss) from unconsolidated entities | 1 |
| (1 | ) |
Net income | $ | 175 |
| $ | 227 |
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Net income (loss) attributable to noncontrolling interests | — |
| — |
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Net income attributable to Kellogg Company | $ | 175 |
| $ | 227 |
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Per share amounts: | | |
Basic | $ | 0.50 |
| $ | 0.64 |
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Diluted | $ | 0.49 |
| $ | 0.64 |
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Dividends per share | $ | 0.50 |
| $ | 0.49 |
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Average shares outstanding: | | |
Basic | 351 |
| 355 |
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Diluted | 355 |
| 357 |
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Actual shares outstanding at period end | 350 |
| 353 |
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Refer to Notes to Consolidated Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(millions)
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| | | | | | | | | |
| Quarter ended April 2, 2016 |
(Results are unaudited) | Pre-tax amount | Tax (expense) benefit | After-tax amount |
Net income |
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| $ | 175 |
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Other comprehensive income (loss): |
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Foreign currency translation adjustments | (55 | ) | 29 |
| (26 | ) |
Cash flow hedges: |
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Unrealized gain (loss) on cash flow hedges | (57 | ) | 23 |
| (34 | ) |
Reclassification to net income | 2 |
| (1 | ) | 1 |
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Postretirement and postemployment benefits: |
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Amount arising during the period: |
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Prior service credit (cost) | — |
| — |
| — |
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Reclassification to net income: |
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Net experience loss | 1 |
| — |
| 1 |
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Prior service cost | — |
| — |
| — |
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Other comprehensive income (loss) | $ | (109 | ) | $ | 51 |
| $ | (58 | ) |
Comprehensive income | | | $ | 117 |
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Other comprehensive income (loss) attributable to noncontrolling interests | | | — |
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Comprehensive income attributable to Kellogg Company | | | $ | 117 |
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| Quarter ended April 4, 2015 |
(Results are unaudited) | Pre-tax amount | Tax (expense) benefit | After-tax amount |
Net income | | | $ | 227 |
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Other comprehensive income (loss): | | | |
Foreign currency translation adjustments | (62 | ) | (21 | ) | (83 | ) |
Cash flow hedges: | | | |
Unrealized gain (loss) on cash flow hedges | 8 |
| (1 | ) | 7 |
|
Reclassification to net income | (4 | ) | — |
| (4 | ) |
Postretirement and postemployment benefits: | | | |
Amount arising during the period: | | | |
Prior service credit (cost) | (1 | ) | — |
| (1 | ) |
Reclassification to net income: | | | |
Net experience loss | 1 |
| — |
| 1 |
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Prior service cost | 3 |
| (1 | ) | 2 |
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Other comprehensive income (loss) | $ | (55 | ) | $ | (23 | ) | $ | (78 | ) |
Comprehensive income | | | $ | 149 |
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Other comprehensive income (loss) attributable to noncontrolling interests | | | (1 | ) |
Comprehensive income attributable to Kellogg Company | | | $ | 148 |
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Refer to Notes to Consolidated Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF EQUITY
(millions)
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| Common stock | Capital in excess of par value | Retained earnings | Treasury stock | Accumulated other comprehensive income (loss) | Total Kellogg Company equity | Non-controlling interests | Total equity |
(unaudited) | shares | amount | shares | amount |
Balance, January 3, 2015 | 420 |
| $ | 105 |
| $ | 678 |
| $ | 6,689 |
| 64 |
| $ | (3,470 | ) | $ | (1,213 | ) | $ | 2,789 |
| $ | 62 |
| $ | 2,851 |
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Common stock repurchases | | |
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| | 11 |
| (731 | ) | | (731 | ) | | (731 | ) |
Net income | | | | 614 |
| | | | 614 |
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| 614 |
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Acquisition of noncontrolling interest, net | | | | | | | |
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| 7 |
| 7 |
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VIE deconsolidation | | | | | | | |
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| (58 | ) | (58 | ) |
Dividends | | | | (700 | ) | | | | (700 | ) |
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| (700 | ) |
Other comprehensive loss | | | | | | | (163 | ) | (163 | ) | (1 | ) | (164 | ) |
Stock compensation | | | 51 |
| | | | | 51 |
| | 51 |
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Stock options exercised and other | | | 16 |
| (6 | ) | (5 | ) | 258 |
| | 268 |
| | 268 |
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Balance, January 2, 2016 | 420 |
| $ | 105 |
| $ | 745 |
| $ | 6,597 |
| 70 |
| $ | (3,943 | ) | $ | (1,376 | ) | $ | 2,128 |
| $ | 10 |
| $ | 2,138 |
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Common stock repurchases | | |
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| | 3 |
| (210 | ) | | (210 | ) | | (210 | ) |
Net income | | | | 175 |
| | | | 175 |
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| 175 |
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Dividends | | | | (176 | ) | | | | (176 | ) | | (176 | ) |
Other comprehensive loss | | | | | | | (58 | ) | (58 | ) |
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| (58 | ) |
Stock compensation | | | 15 |
| | | | | 15 |
| | 15 |
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Stock options exercised and other | | | (6 | ) | (1 | ) | (3 | ) | 164 |
| | 157 |
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| 157 |
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Balance, April 2, 2016 | 420 |
| $ | 105 |
| $ | 754 |
| $ | 6,595 |
| 70 |
| $ | (3,989 | ) | $ | (1,434 | ) | $ | 2,031 |
| $ | 10 |
| $ | 2,041 |
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Refer to notes to Consolidated Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
(millions)
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| Quarter ended |
(unaudited) | April 2, 2016 | April 4, 2015 |
Operating activities | | |
Net income | $ | 175 |
| $ | 227 |
|
Adjustments to reconcile net income to operating cash flows: | | |
Depreciation and amortization | 115 |
| 131 |
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Postretirement benefit plan expense (benefit) | (28 | ) | (21 | ) |
Deferred income taxes | — |
| (2 | ) |
Stock compensation | 15 |
| 10 |
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Venezuela remeasurement | 6 |
| — |
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Variable-interest entity impairment | — |
| 25 |
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Other | (33 | ) | 22 |
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Postretirement benefit plan contributions | (17 | ) | (12 | ) |
Changes in operating assets and liabilities, net of acquisitions: | | |
Trade receivables | (201 | ) | (240 | ) |
Inventories | 49 |
| 70 |
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Accounts payable | 89 |
| 92 |
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Accrued income taxes | (13 | ) | 33 |
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Accrued interest expense | 12 |
| 17 |
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Accrued and prepaid advertising, promotion and trade allowances | 12 |
| (12 | ) |
Accrued salaries and wages | (113 | ) | (88 | ) |
All other current assets and liabilities | (63 | ) | (92 | ) |
Net cash provided by (used in) operating activities | 5 |
| 160 |
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Investing activities | | |
Additions to properties | (144 | ) | (148 | ) |
Acquisitions, net of cash acquired | (18 | ) | (117 | ) |
Other | 7 |
| 3 |
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Net cash provided by (used in) investing activities | (155 | ) | (262 | ) |
Financing activities | | |
Net issuances (reductions) of notes payable | (485 | ) | (19 | ) |
Issuances of long-term debt | 1,382 |
| 672 |
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Reductions of long-term debt | (473 | ) | (243 | ) |
Net issuances of common stock | 164 |
| 57 |
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Common stock repurchases | (198 | ) | (285 | ) |
Cash dividends | (176 | ) | (174 | ) |
Other | — |
| 5 |
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Net cash provided by (used in) financing activities | 214 |
| 13 |
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Effect of exchange rate changes on cash and cash equivalents | (5 | ) | (5 | ) |
Increase (decrease) in cash and cash equivalents | 59 |
| (94 | ) |
Cash and cash equivalents at beginning of period | 251 |
| 443 |
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Cash and cash equivalents at end of period | $ | 310 |
| $ | 349 |
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Supplemental cash flow disclosures | | |
Interest paid | $ | 199 |
| $ | 40 |
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Income taxes paid | $ | 59 |
| $ | 50 |
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| | |
Supplemental cash flow disclosures of non-cash investing activities: | | |
Additions to properties included in accounts payable* | $ | 88 |
| $ | 71 |
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*The Q1 2015 Consolidated Statement of Cash Flows has been revised to correctly eliminate the non-cash effect of accrued capital expenditures of $65 million from Changes in accounts payable, resulting in an increase in net cash provided by operations and from Additions to properties, resulting in an increase in net cash provided by investing activities. These revisions were not considered material to the previously issued Q1 2015 financial statements.
Refer to Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
for the quarter ended April 2, 2016 (unaudited)
Note 1 Accounting policies
Basis of presentation
The unaudited interim financial information of Kellogg Company (the Company) included in this report reflects all 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 2015 Annual Report on Form 10-K.
The condensed balance sheet information at January 2, 2016 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 April 2, 2016 are not necessarily indicative of the results to be expected for other interim periods or the full year.
Accounts payable
The Company has an agreement with a third party to provide an accounts payable tracking system which facilitates participating suppliers’ ability to monitor and, if elected, sell payment obligations from the Company to designated third-party financial institutions. Participating suppliers may, at their sole discretion, make offers to sell one or more payment obligations of the Company prior to their scheduled due dates at a discounted price to participating financial institutions. The Company’s goal in entering into this agreement is to capture overall supplier savings, in the form of payment terms or vendor funding, created by facilitating suppliers’ ability to sell payment obligations, while providing them with greater working capital flexibility. We have no economic interest in the sale of these suppliers’ receivables and no direct financial relationship with the financial institutions concerning these services. The Company’s obligations to its suppliers, including amounts due and scheduled payment dates, are not impacted by suppliers’ decisions to sell amounts under this arrangement. However, the Company’s right to offset balances due from suppliers against payment obligations is restricted by this agreement for those payment obligations that have been sold by suppliers. As of April 2, 2016, $566 million of the Company’s outstanding payment obligations had been placed in the accounts payable tracking system, and participating suppliers had sold $392 million of those payment obligations to participating financial institutions. As of January 2, 2016, $501 million of the Company’s outstanding payment obligations had been placed in the accounts payable tracking system, and participating suppliers had sold $407 million of those payment obligations to participating financial institutions.
New accounting standards
Improvements to employee share-based payment accounting. In March 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) as part of its simplification initiative. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted. The Company early adopted the accounting standard update in the first quarter of 2016. The ASU includes multiple provisions intended to simplify various aspects of the accounting for share-based payments. The main provisions of the ASU are as follows:
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• | Excess tax benefits and deficiencies for share-based payments are recorded as an adjustment of income taxes and reflected in operating cash flows after adoption of this ASU. Excess tax benefits and deficiencies were previously recorded in equity and as financing cash flows prior to adoption of this ASU. The Company adopted this provision prospectively and recorded $12 million of excess tax benefits for the first quarter of 2016, which is reported as operating cash flows on the Consolidated Cash Flow Statement. Please see Note 10 for additional information on the adoption of this provision. |
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• | The guidance allows the employer to withhold up to the maximum statutory tax rates in the applicable jurisdictions without triggering liability accounting. The Company's accounting treatment of outstanding equity awards was not impacted by its adoption of this provision of the ASU. |
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• | The guidance allows for a policy election to account for forfeitures as they occur rather than on an estimated basis. The Company is not making this election, and will continue to account for forfeitures on an estimated basis. |
Balance sheet classification of deferred taxes. In November 2015, the FASB issued an ASU to simplify the presentation of deferred income taxes. The ASU requires that deferred tax liabilities and assets be classified as
noncurrent in a classified statement of financial position. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Entities should apply the new guidance either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. Early adoption is permitted. The Company early adopted the updated standard in the first quarter of 2016, on a prospective basis. The year-end 2015 balances for current deferred tax assets and current deferred liabilities was $227 million and $9 million, respectively. Prior period balances have not been adjusted.
Simplifying the presentation of debt issuance costs. In April 2015, the FASB issued an ASU to simplify the presentation of debt issuance costs. The ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption was permitted. Entities should apply the new guidance on a retrospective basis. The Company adopted the updated standard in the first quarter of 2016 with no significant impact on its financial statements.
Simplifying the accounting for measurement-period adjustments. In September 2015, the FASB issued an ASU to simplify the accounting for measurement-period adjustments for items in a business combination. The ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Entities should apply the new guidance prospectively to adjustments to provisional amounts that occur after the effective date of the ASU with earlier application permitted for financial statements that have not been issued. The Company adopted the updated standard in the first quarter of 2016 with no significant impact on its financial statements.
Customer's accounting for fees paid in a cloud computing arrangement. In April 2015, the FASB issued an ASU to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted. Entities should apply the new guidance either; 1) prospectively to all arrangements entered into or materially modified after the effective date or 2) retrospectively. The Company adopted the updated standard prospectively in the first quarter of 2016 with no significant impact on its financial statements.
Accounting standards to be adopted in future periods
Leases. In February 2016, the FASB issued an ASU which will require the recognition of lease assets and lease liabilities by lessees for all leases with terms greater than 12 months. The distinction between finance leases and operating leases will remain, with similar classification criteria as current GAAP to distinguish between capital and operating leases. The principal difference from current guidance is that the lease assets and lease liabilities arising from operating leases will be recognized on the Consolidated Balance Sheet. Lessor accounting remains substantially similar to current GAAP. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact that implementing this ASU will have on its financial statements and disclosures, as well as timing of implementation.
Recognition and measurement of financial assets and liabilities. In January 2016, the FASB issued an ASU which primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption can be elected for all financial statements of fiscal years and interim periods that have not yet been issued or that have not yet been made available for issuance. Entities should apply the update by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company will adopt the updated standard in the first quarter of 2018. The Company does not expect the adoption of this guidance to have a significant impact on its financial statements.
Revenue from contracts with customers. In May 2014, the FASB issued an ASU which provides guidance for accounting for revenue from contracts with customers. The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. To achieve that core principle, an entity would be required to apply the following five steps: 1) identify the contract(s) with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. When the ASU was originally issued it was effective for fiscal years, and interim periods
within those years, beginning after December 15, 2016, and early adoption was not permitted. On July 9, 2015, the FASB decided to delay the effective date of the new revenue standard by one year. The updated standard will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Entities will be permitted to adopt the new revenue standard early, but not before the original effective date. Entities will have the option to apply the final standard retrospectively or use a modified retrospective method, recognizing the cumulative effect of the ASU in retained earnings at the date of initial application. An entity will not restate prior periods if it uses the modified retrospective method, but will be required to disclose the amount by which each financial statement line item is affected in the current reporting period by the application of the ASU as compared to the guidance in effect prior to the change, as well as reasons for significant changes. The Company will adopt the updated standard in the first quarter of 2018. The Company is currently evaluating the impact that implementing this ASU will have on its financial statements and disclosures, as well as whether it will use the retrospective or modified retrospective method of adoption.
Note 2 Sale of accounts receivable
During the quarter ended April 2, 2016, the Company entered into an agreement (the “Receivable Sales Agreement”), to sell, on a revolving basis, certain trade accounts receivable balances to a third party financial institution. Transfers under this agreement are accounted for as sales of receivables resulting in the receivables being de-recognized from the Consolidated Balance Sheet. The Receivable Sales Agreement provides for the continuing sale of certain receivables on a revolving basis until terminated by either party; however the maximum funding from receivables that may be sold at any time is currently $350 million. During the quarter ended April 2, 2016, $53 million of accounts receivable was sold via this arrangement and the Company recorded cash proceeds of the same amount and paid a fee of less than one percent. Cash flows related to the sales of receivables are included in cash from operating activities in the consolidated statement of cash flows. The recorded net loss on sale of receivables is included in other income and expense and is not material.
The Company has no retained interests in the receivables sold, however the Company does have collection and administrative responsibilities for the sold receivables. The Company has not recorded any servicing assets or liabilities as of April 2, 2016 for this agreement as the fair value of these servicing arrangements as well as the fees earned were not material to the financial statements.
Note 3 Goodwill and other intangible assets
Acquisition
In March 2016, the Company completed the acquisition of an organic and natural snack company for $18 million, which was accounted for under the purchase method and financed with cash on hand. The assets, which primarily consist of indefinite lived brand assets, and liabilities are included in the Consolidated Balance Sheet as of April 2, 2016 within the North America Other segment.
Joint Venture
In January 2016, the Company formed a Joint Venture with Tolaram Africa to develop snacks and breakfast foods for the West Africa market. In connection with the formation, the Company contributed the rights to indefinitely use the Company’s brands in these categories, including the Pringles brand. Accordingly, the Company recorded a contribution of $5 million of intangible assets not subject to amortization with a corresponding increase in Investments In Unconsolidated Entities during the quarter ended April 2, 2016, which represents the value attributed to the Pringles brand for this market.
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 |
January 2, 2016 | $ | 131 |
| $ | 3,568 |
| $ | 82 |
| $ | 456 |
| $ | 431 |
| $ | 76 |
| $ | 224 |
| $ | 4,968 |
|
Currency translation adjustment | — |
| — |
| — |
| 3 |
| 1 |
| — |
| 2 |
| 6 |
|
April 2, 2016 | $ | 131 |
| $ | 3,568 |
| $ | 82 |
| $ | 459 |
| $ | 432 |
| $ | 76 |
| $ | 226 |
| $ | 4,974 |
|
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 |
January 2, 2016 | $ | 8 |
| $ | 42 |
| $ | — |
| $ | 5 |
| $ | 45 |
| $ | 6 |
| $ | 10 |
| $ | 116 |
|
Currency translation adjustment | — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
|
April 2, 2016 | $ | 8 |
| $ | 42 |
| $ | — |
| $ | 5 |
| $ | 45 |
| $ | 6 |
| $ | 10 |
| $ | 116 |
|
| | | | | | | | |
Accumulated Amortization | | | | | | | | |
January 2, 2016 | $ | 8 |
| $ | 16 |
| $ | — |
| $ | 4 |
| $ | 11 |
| $ | 6 |
| $ | 2 |
| $ | 47 |
|
Amortization | — |
| 1 |
| — |
| — |
| 1 |
| — |
| — |
| 2 |
|
April 2, 2016 | $ | 8 |
| $ | 17 |
| $ | — |
| $ | 4 |
| $ | 12 |
| $ | 6 |
| $ | 2 |
| $ | 49 |
|
| | | | | | | | |
Intangible assets subject to amortization, net | | | | | | |
January 2, 2016 | $ | — |
| $ | 26 |
| $ | — |
| $ | 1 |
| $ | 34 |
| $ | — |
| $ | 8 |
| $ | 69 |
|
Currency translation adjustment | — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
|
Amortization | — |
| (1 | ) | — |
| — |
| (1 | ) | — |
| — |
| (2 | ) |
April 2, 2016 | $ | — |
| $ | 25 |
| $ | — |
| $ | 1 |
| $ | 33 |
| $ | — |
| $ | 8 |
| $ | 67 |
|
For intangible assets in the preceding table, amortization was $2 million for the quarters ended April 2, 2016 and April 4, 2015. The currently estimated aggregate annual amortization expense for full-year 2016 is approximately $8 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 |
January 2, 2016 | $ | — |
| $ | 1,625 |
| $ | — |
| $ | 158 |
| $ | 416 |
| $ | — |
| $ | — |
| $ | 2,199 |
|
Additions | — |
| — |
| — |
| 18 |
| — |
| — |
| — |
| 18 |
|
Contribution to joint venture | — |
| — |
| — |
| — |
| (5 | ) | — |
| — |
| (5 | ) |
Currency translation adjustment | — |
| — |
| — |
| 1 |
| 13 |
| — |
| — |
| 14 |
|
April 2, 2016 | $ | — |
| $ | 1,625 |
| $ | — |
| $ | 177 |
| $ | 424 |
| $ | — |
| $ | — |
| $ | 2,226 |
|
Note 4 Investments in unconsolidated entities
In September 2015, the Company acquired, for $445 million, a 50% interest in Multipro Singapore Pte. Ltd. (Multipro), a leading distributor of a variety of food products in Nigeria and Ghana and also obtained an option to acquire 24.5% of an affiliated food manufacturing entity under common ownership based on a fixed multiple of future earnings as defined in the agreement (Purchase Option). The amount paid is subject to purchase price adjustments, including the finalization of Multipro’s 2015 earnings as defined in the agreement. The acquisition of the 50% interest is accounted for under the equity method of accounting. The Purchase Option, which was recorded at cost and will be monitored for impairment through the exercise period, which is upon the earlier of the entity achieving a minimum level of earnings as defined in the agreement, in which case the Company has a one year exercise period, or 2020.
The difference between the amount paid for Multipro and the underlying equity in net assets is primarily attributable to intangible assets, a portion of which will be amortized in future periods, and goodwill.
Note 5 Restructuring and cost reduction activities
The Company views its continued spending on restructuring and 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 currently 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.
Project K
Project K, a four-year efficiency and effectiveness program, was announced in November 2013, and is expected to continue generating a significant amount of savings that may 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 is 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 continue 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 Project K will result in total pre-tax charges, once all phases are approved and implemented, of $1.2 to $1.4 billion, with after-tax cash costs, including incremental capital investments, estimated to be $900 million to $1.1 billion. Based on current estimates and actual charges to date, the Company expects the total project charges will consist of asset-related costs totaling $400 to $450 million which will consist primarily of asset impairments, accelerated depreciation and other exit-related costs; employee-related costs totaling $400 to $450 million which will include severance, pension and other termination benefits; and other costs totaling $400 to $500 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 13%), U.S. Specialty (approximately 1%), North America Other (approximately 10%), Europe (approximately 17%), Latin America (approximately 2%), Asia-Pacific (approximately 6%), and Corporate (approximately 33%). Certain costs impacting Corporate relate to additional initiatives to be approved and executed in the future. When these initiatives are fully defined and approved, the Company will update its estimated costs by reportable segment as needed.
Since the inception of Project K, the Company has recognized charges of $862 million that have been attributed to the program. The charges consist of $6 million recorded as a reduction of revenue, $535 million recorded in COGS and $321 million recorded in SGA.
Other Projects
In 2015 the Company initiated the implementation of a zero-based budgeting (ZBB) program in its North America business that is expected to deliver visibility to ongoing annual savings. During 2016 ZBB was expanded to include the international segments of the business. In support of the ZBB initiative, the Company incurred pre-tax charges
of approximately $7 million during the quarter ended April 2, 2016. Total charges of $19 million have been recognized since the inception of the ZBB program.
Total Projects
During the quarter ended April 2, 2016, the Company recorded total charges of $52 million across all restructuring and cost reduction activities. The charges were comprised of $18 million recorded in cost of goods sold (COGS) and $34 million recorded in selling, general and administrative (SGA) expense.
During the quarter ended April 4, 2015, the Company recorded total charges of $68 million across all restructuring and cost reduction activities. The charges were comprised of $2 million being recorded as a reduction of revenue, $32 million recorded in COGS and $34 million recorded in SGA expense.
The tables below provide the details for charges across all restructuring and cost reduction activities incurred during the quarter and year-to-date periods ended April 2, 2016 and April 4, 2015 and program costs to date for programs currently active as of April 2, 2016. |
| | | | | | | | | | |
| Quarter ended | | Program costs to date |
(millions) | April 2, 2016 | April 4, 2015 | | April 2, 2016 |
Employee related costs | $ | 14 |
| $ | 17 |
| | $ | 273 |
|
Asset related costs | 10 |
| 23 |
| | 156 |
|
Asset impairment | — |
| — |
| | 105 |
|
Other costs | 28 |
| 28 |
| | 347 |
|
Total | $ | 52 |
| $ | 68 |
| | $ | 881 |
|
| | | | |
| Quarter ended | | Program costs to date |
(millions) | April 2, 2016 | April 4, 2015 | | April 2, 2016 |
U.S. Morning Foods | $ | 5 |
| $ | 8 |
| | $ | 223 |
|
U.S. Snacks | 20 |
| 9 |
| | 146 |
|
U.S. Specialty | 2 |
| 1 |
| | 13 |
|
North America Other | 9 |
| 6 |
| | 99 |
|
Europe | 14 |
| 19 |
| | 187 |
|
Latin America | — |
| — |
| | 16 |
|
Asia Pacific | — |
| 5 |
| | 74 |
|
Corporate | 2 |
| 20 |
| | 123 |
|
Total | $ | 52 |
| $ | 68 |
| | $ | 881 |
|
For the quarters ended April 2, 2016 and April 4, 2015 employee related costs consist primarily of severance benefits, asset related costs consist primarily of accelerated depreciation, and other costs consist primarily of third-party incremental costs related to the development and implementation of global business capabilities.
At April 2, 2016 total exit cost reserves were $81 million, related to severance payments and other costs of which a substantial portion will be paid out in 2016 and 2017. The following table provides details for exit cost reserves.
|
| | | | | | | | | | | | | | | |
| Employee Related Costs | Asset Impairment | Asset Related Costs | Other Costs | Total |
Liability as of January 2, 2016 | $ | 55 |
| $ | — |
| $ | — |
| $ | 33 |
| $ | 88 |
|
2016 restructuring charges | 14 |
| — |
| 10 |
| 28 |
| 52 |
|
Cash payments | (20 | ) | — |
| (7 | ) | (29 | ) | (56 | ) |
Non-cash charges and other | — |
| — |
| (3 | ) | — |
| (3 | ) |
Liability as of April 2, 2016 | $ | 49 |
| $ | — |
| $ | — |
| $ | 32 |
| $ | 81 |
|
Note 6 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 2 million anti-dilutive potential common shares excluded from the reconciliation for the quarters ended April 2, 2016 and April 4, 2015.
Quarters ended April 2, 2016 and April 4, 2015:
|
| | | | | | | | |
(millions, except per share data) | Net income attributable to Kellogg Company | Average shares outstanding | Earnings per share |
2016 | | | |
Basic | $ | 175 |
| 351 |
| $ | 0.50 |
|
Dilutive potential common shares | | 4 |
| (0.01 | ) |
Diluted | $ | 175 |
| 355 |
| $ | 0.49 |
|
2015 | | | |
Basic | $ | 227 |
| 355 |
| $ | 0.64 |
|
Dilutive potential common shares | | 2 |
| — |
|
Diluted | $ | 227 |
| 357 |
| $ | 0.64 |
|
In February 2014, the Company's board of directors approved a share repurchase program authorizing the repurchase of up to $1.5 billion of our common stock through December 2015. In December 2015, the board of directors approved a new authorization to repurchase of up to $1.5 billion of our common stock beginning in 2016 through December 2017.
During the quarter ended April 2, 2016, the Company repurchased approximately 3 million shares of common stock for a total of $210 million, of which $198 million was paid and $12 million payable at quarter-end. During the quarter ended April 4, 2015, the Company repurchased 4 million shares of common stock for a total of $285 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. Other comprehensive income 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.
Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarters ended April 2, 2016 and April 4, 2015 consisted of the following:
|
| | | | | | | |
(millions) | | | |
Details about AOCI components | Amount reclassified from AOCI | Line item impacted within Income Statement |
| Quarter ended April 2, 2016 | Quarter ended April 4, 2015 | |
(Gains) losses on cash flow hedges: | | | |
Foreign currency exchange contracts | $ | (7 | ) | $ | (7 | ) | COGS |
Foreign currency exchange contracts | — |
| — |
| SGA |
Interest rate contracts | 6 |
| — |
| Interest expense |
Commodity contracts | 3 |
| 3 |
| COGS |
| $ | 2 |
| $ | (4 | ) | Total before tax |
| (1 | ) | — |
| Tax (expense) benefit |
| $ | 1 |
| $ | (4 | ) | Net of tax |
Amortization of postretirement and postemployment benefits: | | | |
Net experience loss | $ | 1 |
| $ | 1 |
| See Note 9 for further details |
Prior service cost | — |
| 3 |
| See Note 9 for further details |
| $ | 1 |
| $ | 4 |
| Total before tax |
| — |
| (1 | ) | Tax (expense) benefit |
| $ | 1 |
| $ | 3 |
| Net of tax |
Total reclassifications | $ | 2 |
| $ | (1 | ) | Net of tax |
Accumulated other comprehensive income (loss) as of April 2, 2016 and January 2, 2016 consisted of the following:
|
| | | | | | |
(millions) | April 2, 2016 | January 2, 2016 |
Foreign currency translation adjustments | $ | (1,340 | ) | $ | (1,314 | ) |
Cash flow hedges — unrealized net gain (loss) | (72 | ) | (39 | ) |
Postretirement and postemployment benefits: | | |
Net experience loss | (15 | ) | (16 | ) |
Prior service cost | (7 | ) | (7 | ) |
Total accumulated other comprehensive income (loss) | $ | (1,434 | ) | $ | (1,376 | ) |
Noncontrolling interests
In December 2012, the Company entered into a series of agreements with a third party including a subordinated loan (VIE Loan) of $44 million which is convertible into approximately 85% of the equity of the entity (VIE). Due to this convertible subordinated loan and other agreements, the Company determined that the entity was a variable interest entity, the Company is the primary beneficiary and the Company has consolidated the financial statements of the VIE. The results of the VIE’s operations are included in the Consolidated Statements of Income for the quarter ended April 4, 2015. During the quarter ended April 4, 2015, the Company determined that certain assets related to the VIE may not be fully recoverable and recorded a non-cash charge of $25 million, which was recorded as other income (expense), net. During the quarter ended July 4, 2015, the 2012 Agreements were terminated and the VIE loan, including related accrued interest and other receivables, were settled. This resulted in the Company no longer being considered the primary beneficiary of the VIE and accordingly, the VIE was deconsolidated as of July 4, 2015.
Note 7 Debt
The following table presents the components of notes payable at April 2, 2016 and January 2, 2016:
|
| | | | | | | | | | | |
| April 2, 2016 | | January 2, 2016 |
(millions) | Principal amount | Effective interest rate (a) | | Principal amount | Effective interest rate |
U.S. commercial paper | $ | 230 |
| 0.71 | % | | $ | 899 |
| 0.45 | % |
Europe commercial paper | 438 |
| (0.03 | )% | | 261 |
| 0.01 | % |
Bank borrowings | 50 |
| | | 44 |
| |
Total | $ | 718 |
| | | $ | 1,204 |
| |
(a) Negative effective interest rates on certain borrowings in Europe are the result of efforts by the European Central Bank to stimulate the economy in the eurozone.
In March 2016, the Company redeemed $475 million of its 7.45% U.S. Dollar Debentures due 2031. In connection with the debt redemption, the Company incurred $153 million of interest expense, consisting primarily of a premium on the tender offer and also including accelerated losses on pre-issuance interest rate hedges, acceleration of fees and debt discount on the redeemed debt and fees related to the tender offer.
In March 2016, the Company issued $750 million of ten-year 3.25% U.S. Dollar Notes and $650 million of thirty-year 4.5% U.S. Dollar Notes, resulting in aggregate net proceeds after debt discount of $1.382 billion. The proceeds from these Notes were used for general corporate purposes, which included repayment of a portion of the Company’s 7.45% U.S. Dollar Debentures due 2031 and a portion of its commercial paper borrowings. 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.
The effective interest rates on debt obligations resulting from the Company’s previous interest rate swaps as of April 2, 2016 were as follows: (a) seven-year 4.45% U.S. Dollar Notes due 2016 – 4.45%; (b) five-year 1.875% U.S. Dollar Notes due 2016 – 1.81%; (c) five-year 1.75% U.S. Dollar Notes due 2017 – 1.71%; (d) seven-year 3.25% U.S. Dollar Notes due 2018 – 2.52%; (e) ten-year 4.15% U.S. Dollar Notes due 2019 – 3.52%; (f) ten-year 4.00% U.S. Dollar Notes due 2020 – 2.98%; (g) ten-year 3.125% U.S. Dollar Notes due 2022 – 2.69%.
Note 8 Stock compensation
The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, restricted stock units, and to a lesser extent, executive performance shares 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 2015 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 was as follows:
|
| | | | | | |
| Quarter ended |
(millions) | April 2, 2016 | April 4, 2015 |
Pre-tax compensation expense | $ | 16 |
| $ | 12 |
|
Related income tax benefit | $ | 6 |
| $ | 4 |
|
As of April 2, 2016, total stock-based compensation cost related to non-vested awards not yet recognized was $133 million and the weighted-average period over which this amount is expected to be recognized was 2 years.
Stock options
During the quarters ended April 2, 2016 and April 4, 2015, 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 2015 Annual Report on Form 10-K.
Quarter ended April 2, 2016:
|
| | | | | | | | | | |
| 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 | 19 |
| $ | 58 |
| | |
| Granted | 3 |
| 76 |
| | |
| Exercised | (3 | ) | 55 |
| | |
| Forfeitures and expirations | — |
| — |
| | |
| Outstanding, end of period | 19 |
| $ | 61 |
| 7.4 | $ | 306 |
|
| Exercisable, end of period | 12 |
| $ | 57 |
| 6.4 | $ | 242 |
|
Quarter ended April 4, 2015:
|
| | | | | | | | | | |
| 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 | 21 |
| $ | 56 |
| | |
| Granted | 3 |
| 64 |
| | |
| Exercised | (1 | ) | 52 |
| | |
| Forfeitures and expirations | — |
| — |
| | |
| Outstanding, end of period | 23 |
| $ | 57 |
| 7.4 | $ | 204 |
|
| Exercisable, end of period | 14 |
| $ | 55 |
| 6.3 | $ | 163 |
|
The weighted-average fair value of options granted was $9.45 per share and $7.20 per share for the quarters ended April 2, 2016 and April 4, 2015, 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 quarter ended April 2, 2016: | 17 | % | 6.9 | 1.60 | % | 2.60 | % |
Grants within the quarter ended April 4, 2015: | 16 | % | 6.9 | 1.98 | % | 3.00 | % |
The total intrinsic value of options exercised was $50 million and $17 million for the quarters ended April 2, 2016 and April 4, 2015, respectively.
Performance shares
In the first quarter of 2016, 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 upon vesting. The number of shares earned could range between 0 and 200% of the target amount depending upon performance achieved over the three year vesting period. The performance conditions of the award include three-year currency-neutral comparable operating profit growth and total shareholder return (TSR) of the Company’s common stock relative to a select group of peer companies.
A Monte Carlo valuation model was used to determine the fair value of the awards. The TSR performance metric is a market condition. Therefore, compensation cost of the TSR condition is fixed at the measurement date and is not revised based on actual performance. The TSR metric was valued as a multiplier of possible levels of comparable
operating profit growth achievement. Compensation cost related to comparable operating profit growth performance is revised for changes in the expected outcome. The 2016 target grant currently corresponds to approximately 195,000 shares, with a grant-date fair value of $76 per share.
Based on the market price of the Company’s common stock at April 2, 2016, the maximum future value that could be awarded to employees on the vesting date for all outstanding performance share awards was as follows:
|
| | | |
(millions) | April 2, 2016 |
2014 Award | $ | 31 |
|
2015 Award | $ | 27 |
|
2016 Award | $ | 30 |
|
The 2013 performance share award, payable in stock, was settled at 35% of target in February 2016 for a total dollar equivalent of $3 million.
Other stock-based awards
During the quarter ended April 2, 2016, the Company granted restricted stock units and a nominal number of restricted stock awards to eligible employees as presented in the following table. Terms of these grants and the Company’s method of determining grant-date fair value were consistent with that described within the stock compensation footnote in the Company’s 2015 Annual Report on Form 10-K.
Quarter ended April 2, 2016:
|
| | | | | |
Employee restricted stock and restricted stock units | Shares(thousands) | Weighted-average grant-date fair value |
Non-vested, beginning of year | 806 |
| $ | 58 |
|
Granted | 547 |
| 70 |
|
Vested | (47 | ) | 55 |
|
Forfeited | (15 | ) | 56 |
|
Non-vested, end of period | 1,291 |
| $ | 63 |
|
Quarter ended April 4, 2015: |
| | | | | |
Employee restricted stock and restricted stock units | Shares(thousands) | Weighted-average grant-date fair value |
Non-vested, beginning of year | 346 |
| $ | 54 |
|
Granted | 563 |
| 58 |
|
Vested | (48 | ) | 51 |
|
Forfeited | (2 | ) | 58 |
|
Non-vested, end of period | 859 |
| $ | 57 |
|
Note 9 Employee benefits
The Company sponsors a number of U.S. and foreign pension plans as well as 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 2015 Annual Report on Form 10-K. Components of Company plan benefit expense for the periods presented are included in the tables below.
Pension
|
| | | | | | |
| Quarter ended |
(millions) | April 2, 2016 | April 4, 2015 |
Service cost | $ | 24 |
| $ | 28 |
|
Interest cost | 44 |
| 53 |
|
Expected return on plan assets | (89 | ) | (100 | ) |
Amortization of unrecognized prior service cost | 3 |
| 3 |
|
Total pension (income) expense | $ | (18 | ) | $ | (16 | ) |
Other nonpension postretirement
|
| | | | | | |
| Quarter ended |
(millions) | April 2, 2016 | April 4, 2015 |
Service cost | $ | 5 |
| $ | 8 |
|
Interest cost | 10 |
| 12 |
|
Expected return on plan assets | (22 | ) | (25 | ) |
Amortization of unrecognized prior service cost (credit) | (3 | ) | — |
|
Total postretirement benefit (income) expense | $ | (10 | ) | $ | (5 | ) |
Postemployment
|
| | | | | | |
| Quarter ended |
(millions) | April 2, 2016 | April 4, 2015 |
Service cost | $ | 2 |
| $ | 2 |
|
Interest cost | 1 |
| 1 |
|
Recognized net loss | 1 |
| 1 |
|
Total postemployment benefit expense | $ | 4 |
| $ | 4 |
|
Company contributions to employee benefit plans are summarized as follows:
|
| | | | | | | | | |
(millions) | Pension | Nonpension postretirement | Total |
Quarter ended: | | | |
April 2, 2016 | $ | 13 |
| $ | 4 |
| $ | 17 |
|
April 4, 2015 | $ | 9 |
| $ | 3 |
| $ | 12 |
|
Full year: | | | |
Fiscal year 2016 (projected) | $ | 28 |
| $ | 15 |
| $ | 43 |
|
Fiscal year 2015 (actual) | $ | 19 |
| $ | 14 |
| $ | 33 |
|
Plan funding strategies may be modified in response to management’s evaluation of tax deductibility, market conditions, and competing investment alternatives.
Note 10 Income taxes
The consolidated effective tax rate for the quarter ended April 2, 2016 was 21% as compared to the prior year’s rate of 25%. The effective rate for the first quarter of 2016 benefited from excess tax benefits from share-based compensation as well as a benefit related to an audit closure. See Note 1 for further discussion regarding the ASU adoption. The effective tax rate for 2015 benefited from a reduction in tax related to current year remitted and unremitted earnings and the completion of certain tax examinations.
As of April 2, 2016, the Company classified $14 million of unrecognized tax benefits as a net current liability. 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 approximately $8 million of projected additions related primarily to ongoing intercompany transfer pricing activity. 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 April 2, 2016; $48 million of this total represents the amount that, if recognized, would affect the Company’s effective income tax rate in future periods.
|
| | | |
(millions) |
January 2, 2016 | $ | 73 |
|
Tax positions related to current year: | |
Additions | 1 |
|
Reductions | — |
|
Tax positions related to prior years: | |
Additions | — |
|
Reductions | — |
|
Settlements | — |
|
April 2, 2016 | $ | 74 |
|
For the quarter ended April 2, 2016, the Company recognized an increase of $1 million for tax-related interest. During the quarter ended April 4, 2015, the Company recognized a decrease of $1 million for tax-related interest. The accrual balance was $18 million at April 2, 2016.
Note 11 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 April 2, 2016 and January 2, 2016 were as follows:
|
| | | | | | |
(millions) | April 2, 2016 | January 2, 2016 |
Foreign currency exchange contracts | $ | 1,628 |
| $ | 1,210 |
|
Interest rate contracts | 683 |
| — |
|
Commodity contracts | 398 |
| 470 |
|
Total | $ | 2,709 |
| $ | 1,680 |
|
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 April 2, 2016 and January 2, 2016, 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 April 2, 2016 or January 2, 2016.
The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of April 2, 2016 and January 2, 2016:
Derivatives designated as hedging instruments
|
| | | | | | | | | | | | | | | | | | | |
| April 2, 2016 | | January 2, 2016 |
(millions) | Level 1 | Level 2 | Total | | Level 1 | Level 2 | Total |
Assets: | | | | | | | |
Foreign currency exchange contracts: | | | | | | | |
Other prepaid assets | $ | — |
| $ | 21 |
| $ | 21 |
| | $ | — |
| $ | 11 |
| $ | 11 |
|
Total assets | $ | — |
| $ | 21 |
| $ | 21 |
|
| $ | — |
| $ | 11 |
| $ | 11 |
|
Liabilities: | | |
| | | |
|
Foreign currency exchange contracts: | | |
| | | |
|
Other current liabilities | $ | — |
| $ | (33 | ) | $ | (33 | ) | | $ | — |
| $ | (10 | ) | $ | (10 | ) |
Interest rate contracts: | | |
| | | |
|
Other current liabilities | — |
| (8 | ) | (8 | ) | | — |
| — |
| — |
|
Commodity contracts: | | |
| | | |
|
Other current liabilities | — |
| (11 | ) | (11 | ) | | — |
| (14 | ) | (14 | ) |
Total liabilities | $ | — |
| $ | (52 | ) | $ | (52 | ) |
| $ | — |
| $ | (24 | ) | $ | (24 | ) |
Derivatives not designated as hedging instruments
|
| | | | | | | | | | | | | | | | | | | |
| April 2, 2016 | | January 2, 2016 |
(millions) | Level 1 | Level 2 | Total | | Level 1 | Level 2 | Total |
Assets: | | | | | | | |
Foreign currency exchange contracts: | | | | | | | |
Other prepaid assets | $ | — |
| $ | 6 |
| $ | 6 |
| | $ | — |
| $ | 18 |
| $ | 18 |
|
Commodity contracts: | | | | | | | |
Other prepaid assets | 10 |
| — |
| 10 |
| | 4 |
| — |
| 4 |
|
Total assets | $ | 10 |
| $ | 6 |
| $ | 16 |
|
| $ | 4 |
| $ | 18 |
| $ | 22 |
|
Liabilities: | | | | | | | |
Foreign currency exchange contracts: | | | | | | | |
Other current liabilities | $ | — |
| $ | (1 | ) | $ | (1 | ) | | $ | — |
| $ | (6 | ) | $ | (6 | ) |
Commodity contracts: | | | | | | | |
Other current liabilities | (8 | ) | — |
| (8 | ) | | $ | (33 | ) | $ | — |
| $ | (33 | ) |
Total liabilities | $ | (8 | ) | $ | (1 | ) | $ | (9 | ) |
| $ | (33 | ) | $ | (6 | ) | $ | (39 | ) |
The Company has designated a portion of its outstanding foreign currency denominated long-term debt as a net investment hedge of a portion of the Company’s investment in its subsidiaries’ foreign currency denominated net assets. The carrying value of this debt was approximately $1.3 billion and $1.2 billion as of April 2, 2016 and January 2, 2016, respectively.
The Company has elected not to offset the fair values of derivative assets and liabilities executed with the same counterparty that are generally subject to enforceable netting agreements. However, if the Company were to offset and record the asset and liability balances of derivatives on a net basis, the amounts presented in the Consolidated Balance Sheet as of April 2, 2016 and January 2, 2016 would be adjusted as detailed in the following table:
|
| | | | | | | | | | | | |
As of April 2, 2016: | | | |
| | Gross Amounts Not Offset in the Consolidated Balance Sheet | |
| Amounts Presented in the Consolidated Balance Sheet | Financial Instruments | Cash Collateral Received/ Posted | Net Amount |
Total asset derivatives | $ | 37 |
| $ | (30 | ) | $ | — |
| $ | 7 |
|
Total liability derivatives | $ | (61 | ) | $ | 30 |
| $ | 13 |
| $ | (18 | ) |
|
| | | | | | | | | | | | |
As of January 2, 2016: | | | | |
| | Gross Amounts Not Offset in the Consolidated Balance Sheet | |
| Amounts Presented in the Consolidated Balance Sheet | Financial Instruments | Cash Collateral Received/ Posted | Net Amount |
Total asset derivatives | $ | 33 |
| $ | (12 | ) | $ | — |
| $ | 21 |
|
Total liability derivatives | $ | (63 | ) | $ | 12 |
| $ | 51 |
| $ | — |
|
The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the quarters ended April 2, 2016 and April 4, 2015 was as follows:
Derivatives in fair value hedging relationships
|
| | | | | | | | |
(millions) | Location of gain (loss) recognized in income | Gain (loss) recognized in income (a) |
| | April 2, 2016 | | April 4, 2015 |
Foreign currency exchange contracts | Other income (expense), net | $ | — |
| | $ | (4 | ) |
Interest rate contracts | Interest expense | 6 |
| | 9 |
|
Total | | $ | 6 |
|
| $ | 5 |
|
| |
(a) | Includes the ineffective portion and amount excluded from effectiveness testing. |
Derivatives in cash flow hedging relationships
|
| | | | | | | | | | | | | | | | | | | | | | | |
(millions) | Gain (loss) recognized in AOCI | Location of gain (loss) reclassified from AOCI | Gain (loss) reclassified from AOCI into income | Location of gain (loss) recognized in income (a) | Gain (loss) recognized in income (a) |
| April 2, 2016 | | April 4, 2015 | | April 2, 2016 | | April 4, 2015 | | April 2, 2016 | | April 4, 2015 |
Foreign currency exchange contracts | $ | 10 |
| | $ | 17 |
| COGS | $ | 7 |
| | $ | 7 |
| Other income (expense), net | $ | — |
| | $ | — |
|
Interest rate contracts | (66 | ) | | (9 | ) | Interest expense | (6 | ) | | — |
| N/A | — |
| | — |
|
Commodity contracts | (1 | ) | | — |
| COGS | (3 | ) | | (3 | ) | Other income (expense), net | — |
| | — |
|
Total | $ | (57 | ) |
| $ | 8 |
| | $ | (2 | ) |
| $ | 4 |
|
| $ | — |
|
| $ | — |
|
| |
(a) | Includes the ineffective portion and amount excluded from effectiveness testing. |
Derivatives and non-derivatives in net investment hedging relationships
|
| | | | | | | |
(millions) | Gain (loss) recognized in AOCI |
| April 2, 2016 | | April 4, 2015 |
Foreign currency denominated long-term debt | $ | (58 | ) | | $ | 57 |
|
Foreign currency exchange contracts | (22 | ) | | — |
|
Total | $ | (80 | ) |
| $ | 57 |
|
Derivatives not designated as hedging instruments
|
| | | | | | | | |
(millions) | Location of gain (loss) recognized in income | Gain (loss) recognized in income |
| | April 2, 2016 | | April 4, 2015 |
Foreign currency exchange contracts | COGS | $ | (9 | ) | | $ | — |
|
Foreign currency exchange contracts | Other income (expense), net | 11 |
| | 2 |
|
Commodity contracts | COGS | 4 |
| | (11 | ) |
Total | | $ | 6 |
|
| $ | (9 | ) |
During the next 12 months, the Company expects $9 million of net deferred losses reported in AOCI at April 2, 2016 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 Baa1 (Moody’s). The fair value of all derivative instruments with credit-risk-related contingent features in a liability position on April 2, 2016 was $31 million. If the credit-risk-related contingent features were triggered as of April 2, 2016, the Company would be required to post collateral of $31 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 April 2, 2016 triggered by credit-risk-related contingent features.
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 April 2, 2016:
|
| | | | | | |
(millions) | Fair Value | Carrying Value |
Current maturities of long-term debt | $ | 1,264 |
| $ | 1,264 |
|
Long-term debt | 6,665 |
| 6,256 |
|
Total | $ | 7,929 |
| $ | 7,520 |
|
Counterparty credit risk concentration and collateral requirements
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 April 2, 2016, 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. In addition, the Company is required to maintain cash margin accounts in connection with its open positions for exchange-traded commodity derivative instruments executed with the counterparty that are subject to enforceable netting agreements. As of April 2, 2016, the Company had no collateral posting requirements related to reciprocal collateralization agreements. As of April 2, 2016 the Company posted $13 million in margin deposits for exchange-traded commodity derivative instruments, 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 April 2, 2016.
Note 12 Contingencies
In connection with the Company’s previous labor negotiations with the union representing the work-force at its Memphis, TN cereal production facility, the National Labor Relations Board (NLRB) filed a complaint alleging unfair labor practices under the National Labor Relations Act in March 2014. In July 2014, a U.S. District Court judge ruled that the Memphis employees were entitled to return to work while the underlying litigation continues and employees subsequently returned to work. In August 2014, an NLRB Administrative Law Judge dismissed the complaint that initiated the underlying litigation. In May 2015, the NLRB reversed the decision of the Administrative Law Judge in favor of the union. The Company is appealing this decision and the case continues. This litigation is not expected to have a material effect on the production or distribution of products from the Memphis, TN facility or a material financial impact on the Company. As of April 2, 2016, the Company has not recorded a liability related to this matter as an adverse outcome is not considered probable. The Company will continue to evaluate the likelihood of potential outcomes for this case as the litigation continues.
Note 13 Venezuela
Venezuela is considered a highly inflationary economy. As such, the functional currency for the Company's operations in Venezuela is the U.S. dollar, which in turn, requires bolivar denominated monetary assets and liabilities to be remeasured into U.S. dollars using an exchange rate at which such balances could be settled as of the balance sheet date. In addition, revenues and expenses are recorded in U.S. dollars at an appropriate rate on the date of the transaction. Gains and losses resulting from the remeasurement of the bolivar denominated monetary assets and liabilities are recorded in earnings.
From February 2013 through July 4, 2015, the Company used the CENCOEX, official rate, which was 6.3 bolivars to the U.S. dollar, to remeasure its Venezuelan subsidiary’s financial statements to U.S. dollars. The CENCOEX official rate was restricted toward goods and services for industry sectors considered essential, which are primarily food, medicines and a few others. In February 2015, the Venezuelan government announced the addition of a new foreign currency exchange system referred to as the Marginal Currency System, or SIMADI.
During 2015, the Company experienced an increase in the amount of time it takes to exchange bolivars for U.S. dollars through the CENCOEX exchange. Due to this reduced availability of U.S. dollars and upon review of U.S. dollar cash needs in the Company's Venezuela operations as of the quarter ended July 4, 2015, the Company concluded that it was no longer able to obtain sufficient U.S. dollars on a timely basis through the CENCOEX exchange resulting in a decision to remeasure our Venezuela subsidiary's financial statements using the SIMADI rate.
In February 2016, the Venezuelan government announced changes to its foreign currency exchange mechanisms, including a 59% devaluation of the CENCOEX (now named DIPRO) official rate from 6.3 bolivars to 10.0 bolivars to the U.S. dollar. Additionally the SIMADI exchange rate was replaced by the DICOM exchange rate, a new floating exchange rate for non-essential imports. The DICOM exchange rate was introduced at 206 bolivars to the U.S. dollar and the Venezuelan government has reported that the DICOM exchange rate will be allowed to float to meet market needs.
The Company has evaluated all of the facts and circumstances surrounding its Venezuelan business and determined that as of April 2, 2016, the DICOM (formerly SIMADI) rate continues to be the appropriate rate to use for remeasuring its Venezuelan subsidiary’s financial statements.
As of April 2, 2016, the published DIPRO and DICOM rates offered were 10.0 and 276.2 bolivars to the U.S. dollar, respectively.
For the quarters ended April 2, 2016 and April 4, 2015, Venezuela represented less than 1% and approximately 2% of total net sales, respectively. The Company’s net monetary assets denominated in the Venezuelan bolivar were immaterial after applying the DICOM and SIMADI exchange rates as of April 2, 2016 and January 2, 2016, respectively.
The Company continues to monitor and actively manage its investment and exposure in Venezuela. The Company’s Venezuelan business does not rely heavily on imports and when items are imported, they are largely exchanged at the DIPRO official rate; however, the Company considers it reasonably possible to utilize alternate exchange mechanisms in the future. The Company is continuing to take actions to further reduce its reliance on imports in order to run its operations without the need for U.S. dollars, including the elimination of imported ingredients where possible and developing a local supply for parts and materials. Less than 2% of the total raw material needs of the Company's Venezuela operations are imported. The Company will continue to monitor local conditions and its ability to obtain U.S. dollars through the various exchange mechanisms available to determine the appropriate rate for remeasurement.
Note 14 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 manages its operations through nine 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. The reportable segments are discussed in greater detail below.
The U.S. Morning Foods operating segment includes cereal, toaster pastries, health and wellness bars, and beverages.
U.S. Snacks includes cookies, crackers, cereal bars, savory snacks and fruit-flavored snacks.
U.S. Specialty primarily represents food away from home channels, including food service, convenience, vending, Girl Scouts and food manufacturing. The food service business is mostly non-commercial, serving institutions such as schools and hospitals. The convenience business includes traditional convenience stores as well as alternate retail outlets.
North America Other includes the U.S. Frozen, Kashi 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 consists of Central and South America and includes Mexico; and Asia Pacific which consists of Sub-Saharan 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.
|
| | | | | | |
| Quarter ended |
(millions) | April 2, 2016 | April 4, 2015 |
Net sales | | |
U.S. Morning Foods | $ | 767 |
| $ | 776 |
|
U.S. Snacks | 832 |
| 854 |
|
U.S. Specialty | 376 |
| 361 |
|
North America Other | 414 |
| 433 |
|
Europe | 598 |
| 607 |
|
Latin America | 192 |
| 295 |
|
Asia Pacific | 216 |
| 230 |
|
Consolidated | $ | 3,395 |
| $ | 3,556 |
|
Operating profit | | |
U.S. Morning Foods | $ | 148 |
| $ | 127 |
|
U.S. Snacks | 83 |
| 80 |
|
U.S. Specialty | 86 |
| 78 |
|
North America Other | 45 |
| 59 |
|
Europe | 70 |
| 61 |
|
Latin America (a) | 23 |
| 51 |
|
Asia Pacific | 17 |
| 12 |
|
Total Reportable Segments | 472 |
| 468 |
|
Corporate (b) | (34 | ) | (84 | ) |
Consolidated | $ | 438 |
| $ | 384 |
|
| |
(a) | Includes non-cash losses totaling $6 million associated with the remeasurement of the financial statements of the Company's Venezuela subsidiary during the quarter ended April 2, 2016. |
| |
(b) | Includes mark-to-market adjustments for pension plans, commodity and foreign currency contracts totaling $(24) million and ($67) million for the quarters ended April 2, 2016 and April 4, 2015, respectively. |
KELLOGG COMPANY
PART I—FINANCIAL INFORMATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business overview
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand Kellogg Company, our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto contained in Item 1 of this report.
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.
Segments and growth targets
We manage our operations through nine 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. The reportable segments are discussed in greater detail in Note 14 within Notes to Consolidated Financial Statements.
We manage our Company for sustainable performance defined by our long-term annual growth targets. Our targeted long-term annual growth is low-single-digit (1 to 3%) for currency-neutral comparable net sales, mid-single-digit (4 to 6%) for currency-neutral comparable operating profit, and high-single-digit (7 to 9%) for currency-neutral comparable diluted net earnings per share (EPS).
Significant items impacting comparability
Project K and cost reduction activities
During 2013, we announced Project K, a four-year efficiency and effectiveness program. The program is expected to generate a significant amount of savings that may 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. We recorded pre-tax charges related to this program of $45 million and $68 million for the quarters ended April 2, 2016 and April 4, 2015, respectively.
In 2015 we initiated the implementation of a zero-based budgeting (ZBB) program in our North America business. During 2016 ZBB is being expanded to include the international segments of the business. In support of the ZBB initiative, we incurred pre-tax charges of approximately $7 million for the quarter ended April 2, 2016.
See the Restructuring and cost reduction activities section for more information.
Acquisitions
In September 2015, we completed the acquisition of Mass Foods, Egypt's leading cereal company for $46 million, or $44 million net of cash and cash equivalents acquired. In our European reportable segment, the acquisition added $5 million in net sales and less than $1 million of operating profit (before integration costs) that impacted the comparability of our reported results for the quarter ended April 2, 2016.
In January 2015, we completed the acquisition of a majority interest in Bisco Misr, the number one packaged biscuits company in Egypt for $125 million, or $117 million net of cash and cash equivalents acquired. The quarter ended April 2, 2016 represents the final reporting period in which year-over-year comparability is impacted for this acquisition. In our European reportable segment, the acquisition added $9 million in net sales and less than $1 million of operating profit (before integration costs) that impacted the comparability of our reported results for the quarter ended April 2, 2016.
Integration and transaction costs
We have incurred integration costs related to the integration of the 2015 acquisitions of Bisco Misr and Mass Foods, the 2015 entry into a joint venture with Tolaram Africa, and the 2012 acquisition of Pringles as we move these
businesses into the Kellogg business model. We recorded pre-tax integration and transaction costs that were less than $1 million for the quarter ended April 2, 2016 and $8 million for the quarter ended April 4, 2015.
Mark-to-market accounting for pension plans, commodities and certain foreign currency contracts
We recognize mark-to-market adjustments for pension plans, commodity contracts, and certain foreign currency contracts as incurred. Actuarial gains/losses for pension plans are recognized in the year they occur. Changes between contract and market prices for commodities contracts and certain foreign currency contracts result in gains/losses that are recognized in the quarter they occur. We recorded pre-tax mark-to-market charges of $24 million and $67 million for the quarters ended April 2, 2016 and April 4, 2015, respectively.
Other costs impacting comparability
During the quarter ended April 2, 2016, we redeemed $475 million of our 7.45% U.S. Dollar Debentures due 2031. In connection with the debt redemption, we incurred $153 million of interest expense, consisting primarily of a premium on the tender offer and also including accelerated losses on pre-issuance interest rate hedges, acceleration of fees and debt discount on the redeemed debt and fees related to the tender offer. Refer to Note 7 within the Notes to Consolidated Financial Statements for further information.
During the quarter ended April 4, 2015, we determined that certain assets related to a variable interest entity may not be fully recoverable and recorded a non-cash $25 million charge to other income (expense). Refer to Note 6 within the Notes to Consolidated Financial Statements for further information.
Venezuela remeasurement
During 2015 we experienced an increase in the amount of time it takes to exchange bolivars for U.S. dollars through the DIPRO (formerly CENCOEX) exchange. Due to this reduced availability of U.S. dollars and upon review of U.S. dollar cash needs in our Venezuela operations as of the quarter ended July 4, 2015, we concluded that we were no longer able to obtain sufficient U.S. dollars on a timely basis through the DIPRO exchange resulting in a decision to remeasure our Venezuela subsidiary's financial statements using the DICOM (formerly SIMADI) rate. We have evaluated all of the facts and circumstances surrounding our Venezuelan business and determined that as of April 2, 2016 the DICOM rate continues to be the appropriate rate to use for remeasuring our Venezuelan subsidiary’s financial statements.
Following the change to the SIMADI rate as of July 4, 2015, certain non-monetary assets related to our Venezuelan subsidiary continued to be remeasured at historical exchange rates. As these assets were utilized by our Venezuelan subsidiary during the second half of 2015 and first quarter of 2016 they were recognized in the income statement at historical exchange rates resulting in an unfavorable impact. We experienced an unfavorable impact of approximately $4 million in the quarter ended April 2, 2016 related to the utilization of these remaining non-monetary assets.
Additionally, with the introduction of the new DICOM floating rate we experienced an unfavorable COGS impact of approximately $2 million in the quarter ended April 2, 2016 related to the utilization of non-monetary assets that were originally acquired after our conversion to the SIMADI rate at July 4, 2015. These non-monetary assets were recognized in the income statement at historical exchange rates during the quarter.
Foreign currency translation and the impact of Venezuela
We evaluate the operating results of our business on a currency-neutral basis. We determine currency-neutral operating results by dividing or multiplying, as appropriate, the current-period local currency operating results by the currency exchange rates used to translate our financial statements in the comparable prior-year period to determine what the current period U.S. dollar operating results would have been if the currency exchange rate had not changed from the comparable prior-year period.
As a result of our decision to change the exchange rate that we use to remeasure our Venezuela subsidiary from DIPRO (formerly CENCOEX) to the DICOM (formerly SIMADI) exchange rate beginning mid-2015, the methodology we use to calculate the impact of foreign currency translation, as described above, results in certain key performance metrics that are difficult to interpret when Venezuela is included in the financial results. To provide additional visibility to our business performance, we have also included key performance metrics excluding our Venezuela business. We believe the use of our standard currency-neutral methodology in combination with the additional visibility provided by excluding Venezuela from our key performance metrics provides important information to more fully understand currency-neutral operating results.
Non-GAAP Measures
Comparability of certain financial measures is affected significantly by several types of financial impacts such as foreign currency translation, integration and transaction costs, mark-to-market adjustments for pension plans, commodities and certain foreign currency contracts, Project K costs, costs associated with the Venezuela remeasurement, costs associated with the early redemption of debt outstanding, acquisitions, and other costs impacting comparability. We believe the use of such non-GAAP measures provides increased transparency and assists investors in understanding our underlying operating performance and segments and in the analysis of ongoing operating trends. All non-GAAP financial measures have been reconciled with the most directly comparable GAAP financial measures.
Non-GAAP financial measures used include comparable net sales, currency-neutral comparable net sales, comparable net sales growth, currency-neutral comparable net sales growth, comparable gross margin, currency-neutral comparable gross margin, comparable gross profit, currency-neutral comparable gross profit, comparable SGA%, currency-neutral comparable SGA%, comparable operating margin, currency-neutral comparable operating margin, comparable operating profit, currency-neutral comparable operating profit, comparable operating profit growth, currency-neutral comparable operating profit growth, comparable income taxes, currency-neutral comparable income taxes, comparable effective tax rate, currency-neutral comparable effective tax rate, comparable net income attributable to Kellogg Company, currency-neutral comparable net income attributable to Kellogg Company, comparable diluted EPS, currency-neutral comparable diluted EPS, comparable diluted EPS growth, and currency-neutral comparable diluted EPS growth.
Financial results
For the quarter ended April 2, 2016, our reported net sales declined by 4.5% due to the effect of currency devaluation. Currency-neutral comparable net sales improved by 6.6%, which includes the benefit of pricing actions in Venezuela to offset cost inflation. Excluding Venezuela, currency-neutral comparable net sales declined by 1.0%, slightly behind our expectations. This decline was primarily due to U.S. Snacks, European cereal, and Mexico cereal which was partially offset by mid-single-digit sales growth in U.S. Specialty, European Snacks, Latin America Snacks, and Asia.
Reported operating profit increased by 14.0%, primarily the result of year-over-year changes in pension mark-to-market, reduced restructuring charges, and improved profitability in several of our U.S. businesses resulting from ZBB savings and timing of brand-building investment. Currency-neutral comparable operating profit increased by 34.9% due to the benefit of the timing of pricing actions in Venezuela to offset cost inflation, and improved profitability in several of our U.S. businesses resulting from ZBB savings and timing of brand-building investment. Excluding Venezuela, currency-neutral comparable operating profit increased by 1.7%, exceeding our expectations.
Reported diluted EPS of $.49 for the quarter was down 23.4% compared to the prior year of $.64. Reported diluted EPS for the quarter was impacted negatively by foreign currency translation ($.36), costs related to the early redemption of debt ($.28), Project K costs ($.12), mark-to-market accounting ($.06), and the remeasurement of the Venezuelan business using the floating DICOM rate ($.02). Currency-neutral comparable diluted EPS of $1.33 increased by 35.7% compared to prior year of $.98 primarily due to the benefit of the timing of pricing actions in Venezuela, exceeding our expectations. Excluding Venezuela, currency-neutral comparable diluted EPS of $.98 increased by 2.1% compared to prior year of $.96, which exceeded our expectations.
Reconciliation of certain non-GAAP Financial Measures |
| | | | | | |
| Quarter ended |
Consolidated results (dollars in millions, except per share data) | April 2, 2016 | April 4, 2015 |
Reported net income attributable to Kellogg Company | $ | 175 |
| $ | 227 |
|
Mark-to-market | (19 | ) | (46 | ) |
Project K and cost reduction activities | (43 | ) | (47 | ) |
Other costs impacting comparability | (99 | ) | (25 | ) |
Integration costs and acquisitions/divestitures | 1 |
| (6 | ) |
Venezuela remeasurement | (6 | ) | — |
|
Comparable net income attributable to Kellogg Company | $ | 341 |
| $ | 351 |
|
Comparable net income attributable to Kellogg Company excluding Venezuela | $ | 339 |
| $ | 343 |
|
Foreign currency impact | (132 | ) | — |
|
Currency-neutral comparable net income attributable to Kellogg Company | $ | 473 |
| $ | 351 |
|
Currency-neutral comparable net income attributable to Kellogg Company excluding Venezuela | $ | 347 |
| $ | 343 |
|
Reported diluted EPS | $ | 0.49 |
| $ | 0.64 |
|
Mark-to-market | (0.06 | ) | (0.13 | ) |
Project K and cost reduction activities | (0.12 | ) | (0.13 | ) |
Other costs impacting comparability | (0.28 | ) | (0.07 | ) |
Integration costs and acquisitions/divestitures | — |
| (0.01 | ) |
Venezuela remeasurement | (0.02 | ) | — |
|
Comparable diluted EPS | $ | 0.97 |
| $ | 0.98 |
|
Comparable diluted EPS excluding Venezuela | $ | 0.96 |
| $ | 0.96 |
|
Foreign currency impact | (0.36 | ) | — |
|
Currency-neutral comparable diluted EPS | $ | 1.33 |
| $ | 0.98 |
|
Currency-neutral comparable diluted EPS growth | 35.7 | % | 3.0 | % |
Currency-neutral comparable diluted EPS excluding Venezuela | $ | 0.98 |
| $ | 0.96 |
|
Currency-neutral comparable diluted EPS growth excluding Venezuela | 2.1 | % | 3.1 | % |
For more information on the reconciling items in the table above, please refer to the Significant items impacting comparability section.
Net sales and operating profit
The following tables provide an analysis of net sales and operating profit performance for the first quarter of 2016 versus 2015:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Quarter ended April 2, 2016 | | | | | | | | | | | | |
(millions) | | U.S. Morning Foods | | U.S. Snacks | | U.S. Specialty | | North America Other | | Europe | | Latin America | | Asia Pacific | | Corporate | | Kellogg Consolidated |
Reported net sales | | $ | 767 |
| | $ | 832 |
| | $ | 376 |
| | $ | 414 |
| | $ | 598 |
| | $ | 192 |
| | $ | 216 |
| | $ | — |
| | $ | 3,395 |
|
Project K and cost reduction activities | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Integration costs and acquisitions/divestitures | | — |
| | — |
| | — |
| | 1 |
| | 14 |
| | — |
| | — |
| | — |
| | 15 |
|
Differences in shipping days | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Comparable net sales | | $ | 767 |
| | $ | 832 |
| | $ | 376 |
| | $ | 413 |
| | $ | 584 |
| | $ | 192 |
| | $ | 216 |
| | $ | — |
| | $ | 3,380 |
|
Comparable net sales excluding Venezuela | | | | | | | | | | |