Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2016
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                     
Commission file number 1-4171
KELLOGG COMPANY
 
State of Incorporation—Delaware
  
IRS Employer Identification No.38-0710690
One Kellogg Square, P.O. Box 3599, Battle Creek, MI 49016-3599
Registrant’s telephone number: 269-961-2000
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or shorter period that the registrant was required to submit and post such files).
Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
Accelerated filer  ¨
Non-accelerated filer  ¨
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨    No  x
Common Stock outstanding as of July 30, 2016 — 350,259,033 shares
 

Table of Contents

KELLOGG COMPANY
INDEX
 
 
Page
 
 
Financial Statements
 
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Quantitative and Qualitative Disclosures about Market Risk
 
Controls and Procedures
 
 
Risk Factors
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
Exhibits


Table of Contents

Part I – FINANCIAL INFORMATION
Item 1. Financial Statements.
Kellogg Company and Subsidiaries
CONSOLIDATED BALANCE SHEET
(millions, except per share data)
 
July 2,
2016 (unaudited)
January 2,
2016 *
Current assets
 
 
Cash and cash equivalents
$
531

$
251

Accounts receivable, net
1,473

1,344

Inventories:
 
 
Raw materials and supplies
322

315

Finished goods and materials in process
894

935

Deferred income taxes
—

227

Other prepaid assets
201

164

Total current assets
3,421

3,236

Property, net of accumulated depreciation of $5,310 and $5,236
3,543

3,621

Investments in unconsolidated entities
435

456

Goodwill
4,963

4,968

Other intangibles, net of accumulated amortization of $51 and $47
2,282

2,268

Pension
246

231

Other assets
497

471

Total assets
$
15,387

$
15,251

Current liabilities
 
 
Current maturities of long-term debt
$
1,144

$
1,266

Notes payable
780

1,204

Accounts payable
1,988

1,907

Accrued advertising and promotion
464

447

Accrued income taxes
83

42

Accrued salaries and wages
238

325

Other current liabilities
574

548

Total current liabilities
5,271

5,739

Long-term debt
6,277

5,275

Deferred income taxes
477

685

Pension liability
922

946

Nonpension postretirement benefits
58

77

Other liabilities
382

391

Commitments and contingencies


Equity
 
 
Common stock, $.25 par value
105

105

Capital in excess of par value
770

745

Retained earnings
6,701

6,597

Treasury stock, at cost
(4,092
)
(3,943
)
Accumulated other comprehensive income (loss)
(1,494
)
(1,376
)
Total Kellogg Company equity
1,990

2,128

Noncontrolling interests
10

10

Total equity
2,000

2,138

Total liabilities and equity
$
15,387

$
15,251

* Condensed from audited financial statements.

Refer to Notes to Consolidated Financial Statements.

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Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF INCOME
(millions, except per share data)
 
Quarter ended
 
Year-to-date period ended
(Results are unaudited)
July 2,
2016
July 4,
2015
 
July 2,
2016
July 4,
2015
Net sales
$
3,268

$
3,498

 
$
6,663

$
7,054

Cost of goods sold
1,998

2,257

 
4,148

4,568

Selling, general and administrative expense
821

829

 
1,628

1,690

Operating profit
449

412

 
887

796

Interest expense
68

58

 
285

112

Other income (expense), net
4

(46
)
 
4

(72
)
Income before income taxes
385

308

 
606

612

Income taxes
106

85

 
153

161

Earnings (loss) from unconsolidated entities
1

(1
)
 
2

(2
)
Net income
$
280

$
222

 
$
455

$
449

Net income (loss) attributable to noncontrolling interests
—

(1
)
 
—

(1
)
Net income attributable to Kellogg Company
$
280

$
223

 
$
455

$
450

Per share amounts:
 
 
 
 
 
Basic
$
0.80

$
0.63

 
$
1.30

$
1.27

Diluted
$
0.79

$
0.63

 
$
1.29

$
1.26

Dividends per share
$
0.50

$
0.49

 
$
1.00

$
0.98

Average shares outstanding:
 
 
 
 
 
Basic
350

353

 
350

354

Diluted
354

355

 
354

356

Actual shares outstanding at period end




 
349

353

Refer to Notes to Consolidated Financial Statements.

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Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(millions)

Quarter ended
July 2, 2016

Year-to-date period ended
July 2, 2016
(Results are unaudited)
Pre-tax
amount
Tax (expense)
benefit
After-tax
amount

Pre-tax
amount
Tax (expense)
benefit
After-tax
amount
Net income
 
 
$
280

 
 
 
$
455

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
(48
)
(16
)
(64
)
 
(103
)
13

(90
)
Cash flow hedges:
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedges
(3
)
1

(2
)
 
(60
)
24

(36
)
Reclassification to net income
6

(2
)
4

 
8

(3
)
5

Postretirement and postemployment benefits:
 
 
 
 
 
 
 
Amount arising during the period:
 
 
 
 
 
 
 
Prior service cost
(1
)
—

(1
)
 
(1
)
—

(1
)
Reclassification to net income:
 
 
 
 
 
 
 
Net experience loss
1

—

1

 
2

—

2

Prior service cost
2

 
2

 
2

 
2

Other comprehensive income (loss)
$
(43
)
$
(17
)
$
(60
)
 
$
(152
)
$
34

$
(118
)
Comprehensive income
 
 
$
220

 
 
 
$
337

Comprehensive income attributable to Kellogg Company
 
 
$
220

 
 
 
$
337















 
Quarter ended
July 4, 2015

Year-to-date period ended
July 4, 2015
(Results are unaudited)
Pre-tax
amount
Tax (expense)
benefit
After-tax
amount

Pre-tax
amount
Tax (expense)
benefit
After-tax
amount
Net income
 
 
$
222

 
 
 
$
449

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
9

5

14

 
(54
)
(16
)
(70
)
Cash flow hedges:
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedges
(4
)
—

(4
)
 
4

(1
)
3

Reclassification to net income
(3
)
—

(3
)
 
(7
)
—

(7
)
Postretirement and postemployment benefits:
 
 
 
 
 
 
 
Amount arising during the period:
 
 
 
 
 
 
 
Prior service credit (cost)
1

—

1

 
—

—

—

Reclassification to net income:
 
 
 
 
 
 
 
Net experience loss
1

—

1

 
2

—

2

Prior service cost
2

(1
)
1

 
5

(2
)
3

Other comprehensive income (loss)
$
6

$
4

$
10

 
$
(50
)
$
(19
)
$
(69
)
Comprehensive income
 
 
$
232

 
 
 
$
380

Net Income (loss) attributable to noncontrolling interest
 
 
(1
)
 
 
 
(1
)
Other comprehensive income (loss) attributable to noncontrolling interests
 
 
—

 
 
 
(1
)
Comprehensive income attributable to Kellogg Company
 
 
$
233

 
 
 
$
382

Refer to Notes to Consolidated Financial Statements.

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Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF EQUITY
(millions)
 
 
 
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

Common stock repurchases
 
 


 
11

(731
)
 
(731
)
 
(731
)
Net income
 
 
 
614

 
 
 
614



614

Acquisition of noncontrolling interest, net
 
 
 
 
 
 
 


7

7

VIE deconsolidation
 
 
 
 
 
 
 


(58
)
(58
)
Dividends
 
 
 
(700
)
 
 
 
(700
)


(700
)
Other comprehensive loss
 
 
 
 
 
 
(163
)
(163
)
(1
)
(164
)
Stock compensation
 
 
51

 
 
 
 
51

 
51

Stock options exercised and other
 
 
16

(6
)
(5
)
258

 
268

 
268

Balance, January 2, 2016
420

$
105

$
745

$
6,597

70

$
(3,943
)
$
(1,376
)
$
2,128

$
10

$
2,138

Common stock repurchases
 
 


 
5

(386
)
 
(386
)
 
(386
)
Net income
 
 
 
455

 
 
 
455



455

Dividends
 
 
 
(351
)
 
 
 
(351
)
 
(351
)
Other comprehensive loss
 
 
 
 
 
 
(118
)
(118
)


(118
)
Stock compensation
 
 
30

 
 
 
 
30

 
30

Stock options exercised and other
 
 
(5
)


(4
)
237

 
232



232

Balance, July 2, 2016
420

$
105

$
770

$
6,701

71

$
(4,092
)
$
(1,494
)
$
1,990

$
10

$
2,000

Refer to notes to Consolidated Financial Statements.

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Kellogg Company and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
(millions)
 
 
Year-to-date period ended
(unaudited)
July 2,
2016
July 4,
2015
Operating activities
 
 
Net income
$
455

$
449

Adjustments to reconcile net income to operating cash flows:
 
 
Depreciation and amortization
251

269

Postretirement benefit plan expense (benefit)
(56
)
(41
)
Deferred income taxes
7

(11
)
Stock compensation
30

21

Venezuela remeasurement
11

152

Variable-interest entity impairment
—

(49
)
Other
—

35

Postretirement benefit plan contributions
(23
)
(17
)
Changes in operating assets and liabilities, net of acquisitions:
 
 
Trade receivables
(159
)
(207
)
Inventories
17

5

Accounts payable
157

154

Accrued income taxes
54

(34
)
Accrued interest expense
(2
)
(2
)
Accrued and prepaid advertising and promotion
10

9

Accrued salaries and wages
(87
)
(61
)
All other current assets and liabilities
(17
)
(91
)
Net cash provided by (used in) operating activities
648

581

Investing activities
 
 
Additions to properties
(249
)
(258
)
Acquisitions, net of cash acquired
(15
)
(117
)
Investments in unconsolidated entities, net proceeds

29

—

Other
(15
)
42

Net cash provided by (used in) investing activities
(250
)
(333
)
Financing activities
 
 
Net issuances (reductions) of notes payable
(424
)
114

Issuances of long-term debt
2,061

672

Reductions of long-term debt
(1,227
)
(606
)
Net issuances of common stock
233

90

Common stock repurchases
(386
)
(285
)
Cash dividends
(351
)
(347
)
Other
—

5

Net cash provided by (used in) financing activities
(94
)
(357
)
Effect of exchange rate changes on cash and cash equivalents
(24
)
(40
)
Increase (decrease) in cash and cash equivalents
280

(149
)
Cash and cash equivalents at beginning of period
251

443

Cash and cash equivalents at end of period
$
531

$
294

 
 
 
Supplemental cash flow disclosures
 
 
Interest paid
$
284

$
114

Income taxes paid
$
85

$
240

 
 
 
Supplemental cash flow disclosures of non-cash investing activities:
 
 
Additions to properties included in accounts payable*
$
89

$
96

*The Q2 2015 Consolidated Statement of Cash Flows has been revised to correctly eliminate the non-cash effect of accrued capital expenditures of $40 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 Q2 2015 financial statements.
Refer to Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements
for the quarter ended July 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 adjustments, all of which are of a normal and recurring nature, 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 July 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 July 2, 2016, $622 million of the Company’s outstanding payment obligations had been placed in the accounts payable tracking system, and participating suppliers had sold $475 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:
•
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 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.
•
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

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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

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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

In March 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 receivables that may be sold at any time is $550 million (increased from $350 million as of April 2, 2016).  During the year-to-date period ended July 2, 2016, $529 million of accounts receivable have been sold via this arrangement. Accounts receivable sold of $517 million remained outstanding under this arrangement as of July 2, 2016. The proceeds from these 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 July 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 brands, and liabilities are included in the Consolidated Balance Sheet as of July 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 year-to-date period ended July 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

(8
)
(1
)
1

(5
)
July 2, 2016
$
131

$
3,568

$
82

$
459

$
423

$
75

$
225

$
4,963



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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
—

—

—

—

—

—

—

—

July 2, 2016
$
8

$
42

$
—

$
5

$
45

$
6

$
10

$
116

 
 
 
 
 
 
 
 
 
Accumulated Amortization
 
 
 
 
 
 
 
 
January 2, 2016
$
8

$
16

$
—

$
4

$
11

$
6

$
2

$
47

Amortization
—

2

—

—

2

—

—

4

July 2, 2016
$
8

$
18

$
—

$
4

$
13

$
6

$
2

$
51

 
 
 
 
 
 
 
 
 
Intangible assets subject to amortization, net
 
 
 
 
 
 
January 2, 2016
$
—

$
26

$
—

$
1

$
34

$
—

$
8

$
69

Currency translation adjustment
—

—

—

—

—

—

—

—

Amortization
—

(2
)
—

—

(2
)
—

—

(4
)
July 2, 2016
$
—

$
24

$
—

$
1

$
32

$
—

$
8

$
65

For intangible assets in the preceding table, amortization was $4 million for the year-to-date periods ended July 2, 2016 and July 4, 2015. The currently estimated aggregate annual amortization expense for full-year 2016 is approximately $7 million.
Intangible assets not subject to amortization
(millions)
U.S.
Morning
Foods
U.S.
Snacks
U.S.
Specialty
North
America
Other
Europe
Latin
America
Asia
Pacific
Consoli-
dated
January 2, 2016
$
—

$
1,625

$
—

$
158

$
416

$
—

$
—

$
2,199

Additions
—

—

—

18

—

—

—

18

Contribution to joint venture
—

—

—

—

(5
)
—

—

(5
)
Currency translation adjustment
—

—

—

1

4

—

—

5

July 2, 2016
$
—

$
1,625

$
—

$
177

$
415

$
—

$
—

$
2,217


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 purchase price was subject to final adjustments based on Multipro’s 2015 earnings, as defined in the agreement, which was finalized during the quarter ended July 2, 2016. The final purchase price adjustment resulted in a $28 million reduction in the purchase price, which reduced the carrying amount of the investment. 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.

11
Table of Contents

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. Additionally, the Company expects that these savings may be used to drive future growth in the business.

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 17%), U.S. Specialty (approximately 1%), North America Other (approximately 10%), Europe (approximately 17%), Latin America (approximately 2%), Asia-Pacific (approximately 6%), and Corporate (approximately 29%). 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 $924 million that have been attributed to the program. The charges consist of $6 million recorded as a reduction of revenue, $571 million recorded in COGS and $347 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 $12 million and $17 million during the quarter and year-to-date period ended July 2, 2016, respectively. Total charges of $29 million have been recognized since the inception of the ZBB program.

Total Projects
During the quarter ended July 2, 2016, the Company recorded total charges of $72 million across all restructuring and cost reduction activities. The charges were comprised of $36 million recorded in cost of goods sold (COGS) and $36 million recorded in selling, general and administrative (SGA) expense. During the year-to-date period ended July 2, 2016, the Company recorded total charges of $124 million across all restructuring and cost reduction activities. The charges consist of $54 million recorded in COGS and $70 million recorded in SGA expense.
During the quarter ended July 4, 2015, the Company recorded total charges of $90 million across all restructuring and cost reduction activities. The charges consist of $65 million recorded in COGS and $25 million recorded in SGA expense. During the year-to-date period ended July 4, 2015, the Company recorded total charges of $158 million across all restructuring and cost reduction activities. The charges consist of $2 million recorded as a reduction of revenue, $97 million recorded in COGS and $59 million recorded in SGA expense.

12
Table of Contents

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 July 2, 2016 and July 4, 2015 and program costs to date for programs currently active as of July 2, 2016.
 
Quarter ended
 
Year-to-date period ended
 
Program costs to date
(millions)
July 2, 2016
July 4, 2015
 
July 2, 2016
July 4, 2015
 
July 2, 2016
Employee related costs
$
6

$
16

 
$
20

$
33

 
$
279

Asset related costs
17

24

 
27

47

 
173

Asset impairment
16

18

 
16

18

 
121

Other costs
33

32

 
61

60

 
380

Total
$
72

$
90

 
$
124

$
158

 
$
953

 
 
 
 
 
 
 
 
 
Quarter ended
 
Year-to-date period ended
 
Program costs to date
(millions)
July 2, 2016
July 4, 2015
 
July 2, 2016
July 4, 2015
 
July 2, 2016
U.S. Morning Foods
$
4

$
13

 
$
9

$
21

 
$
227

U.S. Snacks
34

10

 
54

19

 
180

U.S. Specialty
1

1

 
3

2

 
14

North America Other
4

23

 
13

29

 
103

Europe
14

25

 
28

44

 
201

Latin America
4

1

 
4

1

 
20

Asia Pacific
4

3

 
4

8

 
78

Corporate
7

14

 
9

34

 
130

Total
$
72

$
90

 
$
124

$
158

 
$
953

For the quarters ended July 2, 2016 and July 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 July 2, 2016 total exit cost reserves were $70 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
20

16

27

61

124

Cash payments
(35
)
—

(11
)
(64
)
(110
)
Non-cash charges and other
—

(16
)
(16
)
—

(32
)
Liability as of July 2, 2016
$
40

$
—

$
—

$
30

$
70


13
Table of Contents

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 3 million and 2 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended July 2, 2016, respectively. There were 3 million and 2 million anti dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended July 4, 2015, respectively.

Quarters ended July 2, 2016 and July 4, 2015:
(millions, except per share data)
Net income
attributable to
Kellogg Company
Average
shares
outstanding
Earnings
per share
2016
 
 
 
Basic
$
280

350

$
0.80

Dilutive potential common shares
 
4

(0.01
)
Diluted
$
280

354

$
0.79

2015
 
 
 
Basic
$
223

353

$
0.63

Dilutive potential common shares
 
2

—

Diluted
$
223

355

$
0.63


Year-to-date periods ended July 2, 2016 and July 4, 2015:
(millions, except per share data)
Net income
attributable to
Kellogg Company
Average
shares
outstanding
Earnings
per share
2016
 
 
 
Basic
$
455

350

$
1.30

Dilutive potential common shares
 
4

(0.01
)
Diluted
$
455

354

$
1.29

2015
 
 
 
Basic
$
450

354

$
1.27

Dilutive potential common shares
 
2

(0.01
)
Diluted
$
450

356

$
1.26

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 year-to-date period ended July 2, 2016, the Company repurchased approximately 5 million shares of common stock for a total of $386 million. During the year-to-date period ended July 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.

14
Table of Contents

Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended July 2, 2016 consisted of the following:

(millions)
  
  
  
Details about AOCI
components
Amount reclassified
from AOCI
Line item impacted
within Income Statement
 
Quarter ended
July 2, 2016
Year-to-date period ended
July 2, 2016
  
(Gains) losses on cash flow hedges:
 
 
 
Foreign currency exchange contracts
$
—

$
(7
)
COGS
Foreign currency exchange contracts
—

—

SGA
Interest rate contracts
2

8

Interest expense
Commodity contracts
4

7

COGS
 
$
6

$
8

Total before tax
 
(2
)
(3
)
Tax expense (benefit)
 
$
4

$
5

Net of tax
Amortization of postretirement and postemployment benefits:
 
 
 
Net experience loss
$
1

$
2

See Note 9 for further details
Prior service cost
2

2

See Note 9 for further details
 
$
3

$
4

Total before tax
 
—

—

Tax expense (benefit)
 
$
3

$
4

Net of tax
Total reclassifications
$
7

$
9

Net of tax

15
Table of Contents

Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended July 4, 2015 consisted of the following:

(millions)
  
  
  
Details about AOCI
components
Amount reclassified
from AOCI
Line item impacted
within Income Statement
 
Quarter ended
July 4, 2015
Year-to-date period ended
July 4, 2015
  
(Gains) losses on cash flow hedges:
 
 
 
Foreign currency exchange contracts
$
(9
)
$
(16
)
COGS
Foreign currency exchange contracts
2

2

SGA
Interest rate contracts
1

1

Interest expense
Commodity contracts
3

6

COGS
 
$
(3
)
$
(7
)
Total before tax
 
—

—

Tax expense (benefit)
 
$
(3
)
$
(7
)
Net of tax
Amortization of postretirement and postemployment benefits:
 
 
 
Net experience loss
$
1

$
2

See Note 9 for further details
Prior service cost
2

5

See Note 9 for further details
 
$
3

$
7

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

$
5

Net of tax
Total reclassifications
$
(1
)
$
(2
)
Net of tax
Accumulated other comprehensive income (loss) as of July 2, 2016 and January 2, 2016 consisted of the following:
(millions)
July 2,
2016
January 2,
2016
Foreign currency translation adjustments
$
(1,404
)
$
(1,314
)
Cash flow hedges — unrealized net gain (loss)
(70
)
(39
)
Postretirement and postemployment benefits:
 
 
Net experience loss
(14
)
(16
)
Prior service cost
(6
)
(7
)
Total accumulated other comprehensive income (loss)
$
(1,494
)
$
(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 six months period ended July 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, resulting in a partial reversal of the prior quarter charge of $6 million for the quarter ended July 4, 2015.  The net charge in the year-to-date period ended July 4, 2015 of $19 million was recorded in Other income (expense), net.  Upon termination of the 2013 Agreements, the Company is no longer considered the primary beneficiary of the VIE and accordingly, the VIE was deconsolidated as of July 4, 2015.  In connection with the deconsolidation, the Company derecognized all assets and liabilities of the VIE, including an allocation of a portion of goodwill from the U.S. Snacks operating segment, resulting in a $67 million non-cash gain, which was recorded within SGA expense for the quarter ended July 4, 2015.

16
Table of Contents


Note 7 Debt
The following table presents the components of notes payable at July 2, 2016 and January 2, 2016:
 
 
July 2, 2016
 
January 2, 2016
(millions)
Principal
amount
Effective
interest rate (a)
 
Principal
amount
Effective
interest rate
U.S. commercial paper
$
425

0.70
 %
 
$
899

0.45
%
Europe commercial paper
328

(0.09
)%
 
261

0.01
%
Bank borrowings
27

 
 
44

 
Total
$
780

 
 
$
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 May 2016, the Company issued €600 million (approximately $664 million USD at July 2, 2016, which reflects the discount and translation adjustments) of eight-year 1.00% Euro Notes due 2024, resulting in aggregate net proceeds after debt discount of $679 million . The proceeds from these Notes were used for general corporate purposes, including, together with cash on hand and additional commercial paper borrowings, repayment of the Company's $750 million, five-year 4.45% U.S. Dollar Notes due 2016 at maturity. 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 Notes were designated as a net investment hedge of the Company's investment in its Europe subsidiary when issued.

In the second quarter of 2016 the Company entered into interest rate swaps with notional amounts totaling approximately $958 million and €600 million which effectively converted $600 million of its 4.0% ten-year U.S. Dollar Notes due 2020, $358 million of its 3.125% U.S. Dollar Notes due 2022 and €600 million of its 1.00% Euro Notes due 2024 from fixed to floating rate obligations. The U.S. Dollar interest rate swaps were settled during the quarter for an unrealized gain of $12 million which will be amortized to interest expense over the remaining term of the related Notes.

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 interest rate swaps as of July 2, 2016 were as follows: (a) five-year 1.875% U.S. Dollar Notes due 2016 – 1.91%; (b) five-year 1.75% U.S. Dollar Notes due 2017 –  1.83%; (c) seven-year 3.25% U.S. Dollar Notes due 2018 – 2.58%; (d) ten-year 4.15% U.S. Dollar Notes due 2019 – 3.55%; (e) ten-year 4.00% U.S. Dollar Notes due 2020 – 2.99%; (f) ten-year 3.125% U.S. Dollar Notes due 2022 – 2.51%; (g) eight-year 1.00% Euro Notes due 2024 - 0.82%.
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.

17
Table of Contents

The Company classifies pre-tax stock compensation expense in COGS and 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
 
Year-to-date period ended
(millions)
July 2, 2016
July 4, 2015
 
July 2, 2016
July 4, 2015
Pre-tax compensation expense
$
17

$
13

 
$
33

$
25

Related income tax benefit
$
6

$
5

 
$
12

$
9

As of July 2, 2016, total stock-based compensation cost related to non-vested awards not yet recognized was $115 million and the weighted-average period over which this amount is expected to be recognized was 2 years.
Stock options
During the year-to-date periods ended July 2, 2016 and July 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.
Year-to-date period ended July 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
(4
)
56

 
 
 
Forfeitures and expirations
—

—

 
 
 
Outstanding, end of period
18

$
61

7.2
$
335

 
Exercisable, end of period
10

$
57

6.2
$
247

Year-to-date period ended July 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
(2
)
53

 
 
 
Forfeitures and expirations
—

—

 
 
 
Outstanding, end of period
22

$
57

7.1
$
131

 
Exercisable, end of period
13

$
55

6.1
$
114



18
Table of Contents

The weighted-average fair value of options granted was $9.44 per share and $7.20 per share for the year-to-date periods ended July 2, 2016 and July 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 July 2, 2016:
17
%
6.9
1.60
%
2.60
%
Grants within the quarter ended July 4, 2015:
16
%
6.9
1.98
%
3.00
%
The total intrinsic value of options exercised was $79 million and $23 million for the year-to-date periods ended July 2, 2016 and July 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 188,000 shares, with a grant-date fair value of $76 per share.
Based on the market price of the Company’s common stock at July 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)
July 2, 2016
2014 Award
$
32

2015 Award
$
27

2016 Award
$
31

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 year-to-date period ended July 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.

19
Table of Contents

Year-to-date period ended July 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
574

70

Vested
(51
)
55

Forfeited
(55
)
62

Non-vested, end of period
1,274

$
63

Year-to-date period ended July 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
(79
)
51

Forfeited
(17
)
56

Non-vested, end of period
813

$
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
 
Year-to-date period ended
(millions)
July 2, 2016
July 4, 2015
 
July 2, 2016
July 4, 2015
Service cost
$
25

$
28

 
$
49

$
56

Interest cost
44

53

 
88

106

Expected return on plan assets
(90
)
(100
)
 
(179
)
(200
)
Amortization of unrecognized prior service cost
4

3

 
7

6

Total pension (income) expense
$
(17
)
$
(16
)
 
$
(35
)
$
(32
)
Other nonpension postretirement
 
Quarter ended
 
Year-to-date period ended
(millions)
July 2, 2016
July 4, 2015
 
July 2, 2016
July 4, 2015
Service cost
$
5

$
9

 
$
10

$
17

Interest cost
9

13

 
19

25

Expected return on plan assets
(23
)
(25
)
 
(45
)
(50
)
Amortization of unrecognized prior service cost (credit)
(2
)
(1
)
 
(5
)
(1
)
Total postretirement benefit (income) expense
$
(11
)
$
(4
)
 
$
(21
)
$
(9
)

20
Table of Contents

Postemployment
 
Quarter ended
 
Year-to-date period ended
(millions)
July 2, 2016
July 4, 2015
 
July 2, 2016
July 4, 2015
Service cost
$
2

$
1

 
$
4

$
3

Interest cost
1

1

 
2

2

Recognized net loss
1

1

 
2

2

Total postemployment benefit expense
$
4

$
3

 
$
8

$
7

Company contributions to employee benefit plans are summarized as follows:
(millions)
Pension
Nonpension postretirement
Total
Quarter ended:
 
 
 
July 2, 2016
$
2

$
4

$
6

July 4, 2015
$
1

$
4

$
5

Year-to-date period ended:
 
 
 
July 2, 2016
$
15

$
8

$
23

July 4, 2015
$
10

$
7

$
17

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 July 2, 2016 was 27% as compared to the prior year’s rate of 28%. The consolidated effective tax rates for the year-to-date periods ended July 2, 2016 and July 4, 2015 were 25% and 26%, respectively. The effective rate for the first half 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 July 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.

21
Table of Contents

Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the year-to-date period ended July 2, 2016; $50 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
3

Reductions
—

Tax positions related to prior years:
 
Additions
1

Reductions
—

Settlements
—

July 2, 2016
$
77


For the quarter and year-to-date periods ended July 2, 2016, the Company recognized an increase of $1 million and $2 million, respectively, for tax-related interest. During the year-to-date period ended July 4, 2015, the Company recognized tax-related interest and penalties netting to zero. The accrual balance was $19 million at July 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 July 2, 2016 and January 2, 2016 were as follows:
(millions)
July 2,
2016
January 2,
2016
Foreign currency exchange contracts
$
1,288

$
1,210

Interest rate contracts
668

—

Commodity contracts
470

470

Total
$
2,426

$
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 July 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.

22
Table of Contents


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 July 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 July 2, 2016 and January 2, 2016:
Derivatives designated as hedging instruments
 
July 2, 2016
 
January 2, 2016
(millions)
Level 1
Level 2
Total
 
Level 1
Level 2
Total
Assets:
 
 
 
 
 
 
 
Foreign currency exchange contracts:
 
 
 
 
 
 
 
Other prepaid assets
$
—

$
20

$
20

 
$
—

$
11

$
11

Interest rate contracts:
 
 

 
 
 

Other assets (a)
—

10

10

 
—

—

—

Total assets
$
—

$
30

$
30


$
—

$
11

$
11

Liabilities:
 
 

 
 
 

Foreign currency exchange contracts:
 
 

 
 
 

Other current liabilities
$
—

$
(12
)
$
(12
)
 
$
—

$
(10
)
$
(10
)
Commodity contracts:
 
 

 
 
 

Other current liabilities
—

(6
)
(6
)
 
—

(14
)
(14
)
Total liabilities
$
—

$
(18
)
$
(18
)

$
—

$
(24
)
$
(24
)
(a) The fair value of the related hedged portion of the Company's long-term debt, a level 2 liability, was $668 million as of July 2, 2016.
Derivatives not designated as hedging instruments
 
July 2, 2016
 
January 2, 2016
(millions)
Level 1
Level 2
Total
 
Level 1
Level 2
Total
Assets:
 
 
 
 
 
 
 
Foreign currency exchange contracts:
 
 
 
 
 
 
 
Other prepaid assets
$
—

$
9

$
9

 
$
—

$
18

$
18

Commodity contracts:
 
 
 
 
 
 
 
Other prepaid assets
7

—

7

 
4

—

4

Total assets
$
7

$
9

$
16


$
4

$
18

$
22

Liabilities:
 
 
 
 
 
 
 
Foreign currency exchange contracts:
 
 
 
 
 
 
 
Other current liabilities
$
—

$
(5
)
$
(5
)
 
$
—

$
(6
)
$
(6
)
Commodity contracts:
 
 
 
 
 
 
 
Other current liabilities
(16
)
—

(16
)
 
$
(33
)
$
—

$
(33
)
Total liabilities
$
(16
)
$
(5
)
$
(21
)

$
(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 $1.9 billion and $1.2 billion as of July 2, 2016 and January 2, 2016, respectively.

23
Table of Contents

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 July 2, 2016 and January 2, 2016 would be adjusted as detailed in the following table:
As of July 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
$
46

$
(12
)
$
—

$
34

Total liability derivatives
$
(39
)
$
12

$
27

$
—

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

$
—



24
Table of Contents

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the quarters ended July 2, 2016 and July 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)
 
 
July 2,
2016
 
July 4,
2015
Foreign currency exchange contracts
Other income (expense), net
$
—

 
$
—

Interest rate contracts
Interest expense
3

 
(2
)
Total
 
$
3


$
(2
)
(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)
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
Foreign currency  exchange contracts
$
(1
)
 
$
2

COGS
$
—

 
$
9

Other income (expense), net
$
(1
)
 
$
(2
)
Foreign currency exchange contracts
—

 
(6
)
SGA 
expense
—

 
(2
)
Other income (expense), net
—

 
—

Interest rate contracts
(3
)
 
—

Interest 
expense
(2
)
 
(1
)
N/A
—

 
—

Commodity contracts
1

 
—

COGS
(4
)
 
(3
)
Other income (expense), net
—

 
—

Total
$
(3
)

$
(4
)
 
$
(6
)

$
3