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KELLOGG CO - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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. We manage our operations through eight operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. We report results of operations in the following reportable segments: U.S. Morning Foods; U.S. Snacks; U.S. Specialty; North America Other; Europe; Latin America; and Asia Pacific. The reportable segments are discussed in greater detail in Note 11 within Notes to Consolidated Financial Statements. We manage our Company for sustainable performance defined by our long-term annual growth targets. These targets are 3 to 4% for internal net sales, mid-single-digit (4 to 6%) for underlying internal operating profit, and high-single-digit (7 to 9%) for currency-neutral comparable diluted net earnings per share. 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 will be invested in key strategic areas of focus for the business. We expect that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow. See the Restructuring and cost reduction activities section for more information. Comparability Internal net sales growth excludes the impact of foreign currency translation and, if applicable, acquisitions, dispositions and integration costs associated with the acquisition of the Pringles® business (Pringles). Comparability of certain financial measures is impacted significantly by two types of charges: 1) Mark-to-market adjustments that are recorded for pensions and commodity derivative contracts; and 2) Charges related to restructuring and cost reduction activities. To provide increased transparency and assist in understanding our underlying operating performance we use non-GAAP financial measures within the MD&A that exclude the impact of these charges. These non-GAAP financial measures include underlying gross margin, underlying gross profit, underlying SGA%, underlying operating margin, underlying operating profit, underlying operating profit growth, underlying income taxes, underlying effective tax rate, and underlying net income attributable to Kellogg Company. Underlying internal operating profit growth excludes the impact of foreign currency translation and, if applicable, acquisitions, dispositions, integration costs associated with the acquisition of Pringles, mark-to-market adjustments, and charges related to restructuring and cost reduction activities. Additionally, integration costs associated with the acquisition of Pringles are excluded from comparable basic earnings per share (EPS), comparable diluted EPS, and comparable diluted EPS growth. Financial results For the quarter ended September 27, 2014, our reported net sales declined by 2.1% and internal net sales declined by 1.7%. We experienced internal net sales declines in U.S. Morning Foods, U.S. Snacks, U.S. Specialty, North America Other, and Europe. Internal net sales grew in Latin America and Asia Pacific. Reported operating profit declined by 27.5%, and underlying internal operating profit declined by 1.8%. The decline in underlying internal operating profit was driven by softer sales primarily in U.S. Morning Foods, U.S. Snacks, and U.S. Specialty. This was partially offset by net cost deflation, continued discipline in overhead control, reduced incentive compensation to align with performance, and slightly lower investment in brand-building. Reported diluted EPS of $.62 for the quarter was down 31.1% compared to the prior year of $.90. Comparable diluted EPS of $.94 for the quarter was down 3.1% compared to the prior year of $.97. As a result of 2014 incentive compensation being reduced in the current quarter to align with performance and the anticipated re-establishment of usual incentive compensation levels in 2015, we expect that increased incentive compensation will result in a 2%-3% headwind for full-year results in 2015. 27-------------------------------------------------------------------------------- Table of Contents Reconciliation of certain non-GAAP Financial Measures Quarter ended Year-to-date period ended Consolidated results September 27, September 28, September 27, September 28, 2014 2013 2014 2013 Reported operating profit $ 365 $ 504 $ 1,446 $ 1,577 Mark-to-market (a) (66 ) 2 38 (59 ) Restructuring and cost reduction activities (b) (92 ) (29 ) (224 ) (49 ) Underlying operating profit (c) $ 523 $ 531 $ 1,632 $ 1,685 Reported income taxes $ 86 $ 124 $ 373 $ 398 Mark-to-market (a) (25 ) - 7 (19 ) Restructuring and cost reduction activities (b) (24 ) (8 ) (62 ) (15 ) Underlying income taxes (c) $ 135 $ 132 $ 428 $ 432 Reported effective income tax rate 27.7 % 27.4 % 28.6 % 28.6 % Mark-to-market (a) (1.3 )% - (0.3 )% (0.2 )% Restructuring and cost reduction activities (b) 0.5 % (0.3 )% 0.2 % 0.0 % Underlying effective income tax rate (c) 28.5 % 27.7 % 28.7 % 28.8 % Reported net income attributable to Kellogg Company $ 225 $ 326 $ 926 $ 989 Mark-to-market (a) (41 ) 2 31 (40 ) Restructuring and cost reduction activities (b) (68 ) (21 ) (162 ) (34 ) Underlying net income attributable to Kellogg Company (c) $ 334 $ 345 $ 1,057 $ 1,063 Reported basic EPS $ 0.63 $ 0.90 $ 2.58 $ 2.72 Mark-to-market (a) (0.11 ) - 0.09 (0.12 ) Pringles integration costs (0.02 ) (0.02 ) (0.05 ) (0.09 ) Restructuring and cost reduction activities (b) (0.19 ) (0.05 ) (0.45 ) (0.09 ) Comparable basic EPS (d) $ 0.95 $ 0.97 $ 2.99 $ 3.02 Comparable basic EPS growth (d) (2.1 )% 2.1 % (1.0 )% 1.3 % Reported diluted EPS $ 0.62 $ 0.90 $ 2.56 $ 2.70 Mark-to-market (a) (0.11 ) - 0.08 (0.12 ) Pringles integration costs (0.02 ) (0.02 ) (0.05 ) (0.09 ) Restructuring and cost reduction activities (b) (0.19 ) (0.05 ) (0.45 ) (0.09 ) Comparable diluted EPS (d) $ 0.94 $ 0.97 $ 2.98 $ 3.00 Comparable diluted EPS growth (d) (3.1 )% 2.1 % (0.7 )% 1.0 % (a) Includes mark-to-market adjustments for pension plans and commodity contracts as reflected in cost of goods sold. Actuarial gains/losses for pension plans are recognized in the year they occur. A portion of these mark-to-market adjustments were capitalized as inventoriable cost at the end of 2013 and 2012. These amounts have been recognized in the first quarter of 2014 and 2013, respectively. During the third quarter of 2014, we remeasured the benefit obligation for an impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate. Mark-to-market adjustments for commodities reflect the changes in the fair value of contracts for the difference between contract and market prices for the underlying commodities. The resulting gains/losses are recognized in the quarter they occur. (b) Costs incurred related primarily to the execution of Project K, a global four-year efficiency and effectiveness program. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories. The 2013 periods presented have been recast to exclude all restructuring and cost reduction activities from underlying and comparable results. Previously, only costs associated with Project K were excluded from underlying and comparable results. (c) Underlying operating profit, underlying income taxes, underlying effective income tax rate, and underlying net income attributable to Kellogg Company are non-GAAP measures that exclude the impact of pension and commodity mark-to-market adjustments and restructuring and cost reduction activities. We believe the use of such non-GAAP measures provides increased transparency and assists in understanding underlying operating performance. These non-GAAP measures are reconciled directly to the comparable measures in accordance with U.S. GAAP within this table. (d) Comparable EPS is a non-GAAP measure that excludes the impact of mark-to-market adjustments on pension plans and commodity contracts, the impact of Project K costs, and the impact of integration costs related to the acquisition of the Pringles business. 28 -------------------------------------------------------------------------------- Table of Contents Net sales and operating profit The following tables provide an analysis of net sales and operating profit performance for the third quarter of 2014 versus 2013: North U.S. U.S. U.S. America Latin Asia Corp- Consol- (dollars in millions) Morning Foods Snacks Specialty Other Europe America Pacific orate idated 2014 net sales $ 841 $ 849 $ 270 $ 369 $ 726 $ 320 $ 264 $ - $ 3,639 2013 net sales $ 883 $ 886 $ 281 $ 382 $ 729 $ 302 $ 253 $ - $ 3,716 % change - 2014 vs. 2013: As Reported (4.7 )% (4.2 )% (4.1 )% (3.5 )% (0.6 )% 6.2 % 4.8 % - % (2.1 )% Acquisitions /Divestitures - % - % - % - % - % - % - % - % - % Integration impact (a) - % - % - % - % - % - % .6 % - % - % Foreign currency impact - % - % - % (2.4 )% - % (1.1 )% (.8 )% - % (.4 )% Internal business (b) (4.7 )% (4.2 )% (4.1 )% (1.1 )% (0.6 )% 7.3 % 5.0 % - % (1.7 )% North U.S. U.S. U.S. America Latin Asia Corp- Consol- (dollars in millions) Morning Foods Snacks Specialty Other Europe America Pacific orate idated 2014 operating profit $ 118 $ 67 $ 59 $ 58 $ 61 $ 50 $ 16 $ (64 ) $ 365 2013 operating profit $ 132 $ 105 $ 70 $ 70 $ 74 $ 39 $ 25 $ (11 ) $ 504 % change - 2014 vs. 2013: As Reported (10.5 )% (36.2 )% (14.2 )% (18.2 )% (17.4 )% 29.5 % (32.1 )% (512.6 )% (27.5 )% Acquisitions/Divestitures - % - % - % - % - % - % - % - % - % Integration impact (a) - % - % - % .3 % .8 % .9 % 3.8 % (27.4 )% .5 % Foreign currency impact (.1 )% - % - % (2.6 )% .6 % (.8 )% (1.4 )% 16.1 % (.3 )% Mark-to-market (c) - % - % - % - % - % - % - % (611.6 )% (13.1 )% Restructuring and cost reduction activities (d) (6.7 )% (26.3 )% .2 % (2.7 )% (22.6 )% 9.6 % (39.8 )% (149.3 )% (12.8 )% Underlying internal (e) (3.7 )% (9.9 )% (14.4 )% (13.2 )% 3.8 % 19.8 % 5.3 % 259.6 % (1.8 )% (a) Includes impact of integration costs associated with the Pringles acquisition. (b) Internal net sales growth for 2014 excludes the impact of acquisitions, divestitures, integration costs and impact of foreign currency translation. Internal net sales growth is a non-GAAP financial measure which is reconciled to the directly comparable measure in accordance with U.S. GAAP within these tables. (c) Includes mark-to-market adjustments for pension plans and commodity contracts as reflected in cost of goods sold. Actuarial gains/losses for pension plans are recognized in the year they occur. A portion of these mark-to-market adjustments were capitalized as inventoriable cost at the end of 2013 and 2012. These amounts have been recognized in the first quarter of 2014 and 2013, respectively. During the third quarter of 2014, we remeasured the benefit obligation for an impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate. Mark-to-market adjustments for commodities reflect the changes in the fair value of contracts for the difference between contract and market prices for the underlying commodities. The resulting gains/losses are recognized in the quarter they occur. (d) Costs incurred related primarily to the execution of Project K, a global four-year efficiency and effectiveness program. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories. The 2013 periods presented have been recast to exclude all restructuring and cost reduction activities from underlying and comparable results. Previously, only costs associated with Project K were excluded from underlying and comparable results. (e) Underlying internal operating profit growth excludes the impact of foreign currency translation, pension plans and commodity contracts mark-to-market adjustments, costs related to restructuring and cost reduction activities, and if applicable, acquisitions, dispositions, and integration costs associated with the acquisition of Pringles. We believe the use of this non-GAAP measure provides increased transparency and assists in understanding underlying operating performance. This non-GAAP measure is reconciled to the directly comparable measure in accordance with U.S. GAAP within this table. U.S. Morning Foods Internal net sales for U.S. Morning Foods declined 4.7% as a result of decreased volume and unfavorable pricing/mix. This segment consists of cereal, toaster pastries, health and wellness bars, and beverages. The cereal category continued to decline during the quarter despite our investments behind category-building programs that started in the second quarter. We realized improvement in our consumption trends, particularly in our kids brands. However, the 29-------------------------------------------------------------------------------- Table of Contents improvements were less than we had expected. We plan to continue our investment behind category-building programs for the remainder of the year. However, we expect our cereal consumption to remain down over the remainder of the year. We continued to see weakness in Special K® as it faces headwinds from evolving consumer trends regarding weight management. As a result, we are changing the positioning of the brand from a focus on dieting to weight wellness. This focus will stress the role that Special K®plays in a healthy lifestyle. We plan to reinvent all aspects of the brand in 2015, including innovation, packaging, advertising, and consumer promotions. Each of these will highlight Special K®'s position as part of a weight wellness program. New packaging and advertising will highlight the simplicity and goodness of the food, new consumer promotions will help consumers meet their goals, and innovation will directly appeal to consumer trends through Special K® Protein, Special K® Gluten Free, Special K® Granola, and additional hot cereal offerings. Toaster pastries reported a sales decline for the quarter as a result of difficult comparisons due to the peanut butter innovations launched in 2013, and the timing of new introductions this year. We plan to introduce a new PB&J innovation in November, and believe that this business will return to growth. Beverages continued to report increased consumption resulting from expanded distribution and innovations. Underlying internal operating profit in U.S. Morning Foods declined 3.7% due to the unfavorable sales performance and a high-single-digit increase in cereal brand-building investment. This was partially offset by net cost deflation, a decrease in brand-building investment behind health and wellness bars and beverages, and continued discipline in overhead control. U.S. Snacks Internal net sales in U.S. Snacks declined 4.2% as a result of decreased volume partially offset by favorable pricing/mix. This segment consists of crackers, cereal bars, cookies, savory snacks, and fruit-flavored snacks. Crackers posted a sales decline, but gained share as a result of the continued success of Cheez-It® innovations and core products in the Townhouse®, and Club® brands due to brand-building support and sales execution. Cheez-It®, Townhouse®, and Club® all reported solid consumption and share gains. The bars business declined for the quarter due to continued weakness in the Special K® and Fiber Plus® brands. The issues with these brands are similar to what we have experienced in the cereal category. To address these issues we have new products and activity planned for introduction in the fourth quarter and next year. Rice Krispies Treats® and Nutri-grain® both gained share during the quarter. The Rice Krispies Treats® performance was the result of good core growth and an innovation launch. We expect this segment to remain challenging for the balance of the year. The cookies business declined in the quarter, resulting in lost share, although both Chips Deluxe® and Fudge Shoppe® gained share. We continued to experience soft performance in our 100-calorie packs business, and the negative impact of a SKU rationalization initiative with impacts expected into early next year. Savory snacks reported solid sales growth and held share for the quarter behind the performance of the core business, Grab 'n Go, and the new Pringles® Tortilla product. Underlying internal operating profit in U.S. Snacks declined by 9.9% due to unfavorable sales performance and net cost inflation. This was partially offset by continued discipline in overhead control and a decrease in brand-building investment. U.S. Specialty Internal net sales in U.S. Specialty declined 4.1% as a result of decreased volume partially offset by favorable pricing/mix. Sales declines were the result of supply issues with a co-packer and an inventory deload as a customer shifted from warehouse to direct delivery. These issues had a significant impact on the business. Excluding these issues, we saw a much better performance driven in part by good results from innovations in Foodservice while gaining share in a number of segments within Foodservice and Convenience businesses. Underlying internal operating profit in U.S. Specialty declined by 14.4% due to the unfavorable sales performance. This was partially offset by discipline in overhead control. North America Other Internal net sales in North America Other (U.S. Frozen and Canada) declined 1.1% due to unfavorable pricing/mix which was partially offset by increased volumes. The U.S. Frozen business reported a slight decline due to product mix costs associated with the launch of new products. New Eggo® Bites continued to do well in the quarter, and we launched new Eggo® handheld sandwiches in September. These sandwiches build on the great brand-value of Eggo® and combine it with the on-trend handheld-sandwich category. This is the first all-family offering in this segment and we are excited about its potential. Canada also reported a slight decline in sales although volumes increased at a low single-digit rate. We gained share in most categories and realized double-digit consumption growth in savory snacks as the launch of Pringles® Tortilla has performed well. Underlying internal operating profit in North America Other declined 13.2% primarily due to unfavorable sales performance and increased brand-building investment. This was partially offset by continued discipline in overhead control. 30 -------------------------------------------------------------------------------- Table of Contents Europe Internal net sales for Europe declined 0.6% as a result of decreased volume and unfavorable pricing/mix. Cereal category consumption remains soft in most developed markets. While the performance posted by individual markets was largely as expected, our most significant challenge in the region remains the performance of Special K®. We have initiatives intended to address this performance planned in 2015 including new communication, an upgrade to the food, improvement in packaging, and better promotional activities. In the UK market, our cereal programs are showing early signs of success. The parent-brand Origins program, and the back-to-school themed program both achieved retail support and execution which drove strong volume improvement in the quarter. Savory snacks reported solid net sales growth in the quarter driven by focus on improving availability, visibility, and awareness. Investment in brand-building for Pringles® increased at a double-digit rate and we saw good results from the summer speaker-can promotion and execution at retail. Underlying internal operating profit in Europe improved 3.8% due to net cost deflation and decreased brand-building investment. This was partially offset by unfavorable sales performance and increased overhead spending. Latin America Latin America's internal net sales improved 7.3% due to favorable pricing/mix which was partially offset by decreased volume. This was the result of growth in Venezuela, Mexico, Mercosur, and the Pringles business as well as strong pricing gains in a majority of our markets. The cereal business posted good results, although we saw some competitive price promotions in Mexico which affected selected segments late in the quarter. The Colombian and Venezuelan businesses gained share as a result of success in the children's and all-family segments. The Special K® brand has regained momentum in Venezuela as the result of increased availability and in Mexico as the result of commercial initiatives. The underlying momentum of the savory snacks business continues, driven by strong commercial programs, innovation, and good execution. Underlying internal operating profit in Latin America improved by 19.8% due to favorable sales performance resulting from strong pricing realization. This was partially offset by net cost inflation and a double-digit increase in brand-building investment. Asia Pacific Internal net sales in Asia Pacific increased 5.0% as a result of increased volume and favorable pricing/mix. The sales increase was the result of double-digit growth in the Asian markets and the savory snacks business across the region. This sales performance was partially offset by continued weakness in the Australian cereal category. The decline in Australia was a sequential improvement from the results posted in the first half of the year. Performance in the quarter benefitted from Special K® innovation and the Breakfast for Better Days parent-brand activity. Underlying internal operating profit in Asia Pacific increased by 5.3% due to favorable sales performance and net cost deflation. This was partially offset by increased overhead spending and increased brand-building investment. Corporate Underlying internal operating profit for Corporate improved as a result of reduced pension costs and discipline in overhead control. 31-------------------------------------------------------------------------------- Table of Contents The following table provides an analysis of net sales and operating profit performance for the year-to-date periods of 2014 as compared to 2013. North U.S. U.S. U.S. America Latin Asia Corp- Consol- (dollars in millions) Morning Foods Snacks Specialty Other Europe America Pacific orate idated 2014 net sales $ 2,522 $ 2,645 $ 918 $ 1,111 $ 2,206 $ 918 $ 746 $ - $ 11,066 2013 net sales $ 2,657 $ 2,704 $ 932 $ 1,173 $ 2,144 $ 914 $ 767 $ - $ 11,291 % change - 2014 vs. 2013: As Reported (5.0 )% (2.2 )% (1.5 )% (5.3 )% 2.9 % 0.5 % (2.6 )% - % (2.0 )% Acquisitions/Divestitures - % - % - % - % - % - % (.1 )% - % - % Integration impact (a) - % - % - % - % - % - % 0.4 % - % - % Foreign currency impact - % - % - % (2.6 )% 3.4 % (2.4 )% (4.2 )% - % (.1 )% Internal business (b) (5.0 )% (2.2 )% (1.5 )% (2.7 )% (0.5 )% 2.9 % 1.3 % - % (1.9 )% North U.S. U.S. U.S. America Latin Asia Corp- Consol- (dollars in millions) Morning Foods Snacks Specialty Other Europe America Pacific orate idated 2014 operating profit $ 389 $ 292 $ 209 $ 192 $ 181 $ 145 $ 32 6 $ 1,446 2013 operating profit $ 475 $ 341 $ 210 $ 223 $ 220 $ 129 $ 63 (84 ) $ 1,577 % change - 2014 vs. 2013: As Reported (18.1 )% (14.6 )% (0.1 )% (14.2 )% (17.9 )% 12.3 % (48.6 )% 107.5 % (8.3 )% Acquisitions/Divestitures - % - % - % - % - % - % 1.2 % - % 0.1 % Integration impact (a) - % 2.9 % - % 0.4 % (.5 )% 0.6 % 5.2 % (18.2 )% 1.2 % Foreign currency impact - % - % - % (3.0 )% 5.2 % 2.0 % (3.3 )% 27.2 % 0.4 % Mark-to-market (c) - % - % - % - % - % - % - % 80.6 % 5.7 % Restructuring and cost reduction activities (d) (6.6 )% (9.5 )% 0.2 % (4.4 )% (25.6 )% (1.5 )% (26.1 )% (97.7 )% (10.8 )% Underlying internal (e) (11.5 )% (8.0 )% (0.3 )% (7.2 )% 3.0 % 11.2 % (25.6 )% 115.6 % (4.9 )% (a) Includes impact of integration costs associated with the Pringles acquisition. (b) Internal net sales growth for 2014 excludes the impact of acquisitions, divestitures, integration costs and impact of foreign currency translation. Internal net sales growth is a non-GAAP financial measure which is reconciled to the directly comparable measure in accordance with U.S. GAAP within these tables. (c) Includes mark-to-market adjustments for pension plans and commodity contracts as reflected in cost of goods sold. Actuarial gains/losses for pension plans are recognized in the year they occur. A portion of these mark-to-market adjustments were capitalized as inventoriable cost at the end of 2013 and 2012. These amounts have been recognized in the first quarter of 2014 and 2013, respectively. During the third quarter of 2014, we remeasured the benefit obligation for an impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate. Mark-to-market adjustments for commodities reflect the changes in the fair value of contracts for the difference between contract and market prices for the underlying commodities. The resulting gains/losses are recognized in the quarter they occur. (d) Costs incurred related primarily to the execution of Project K, a global four-year efficiency and effectiveness program. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories. The 2013 periods presented have been recast to exclude all restructuring and cost reduction activities from underlying and comparable results. Previously, only costs associated with Project K were excluded from underlying and comparable results. (e) Underlying internal operating profit growth excludes the impact of foreign currency translation, pension plans and commodity contracts mark-to-market adjustments, costs related to restructuring and cost reduction activities, and if applicable, acquisitions, dispositions, and integration costs associated with the acquisition of Pringles. We believe the use of this non-GAAP measure provides increased transparency and assists in understanding underlying operating performance. This non-GAAP measure is reconciled to the directly comparable measure in accordance with U.S. GAAP within this table. U.S. Morning Foods Year-to-date internal net sales for U.S. Morning Foods declined 5.0% due to weakness in both the cereal and toaster pastries categories. We are investing behind cereal category-building messaging, but expect that cereal category consumption will be down for the remainder of the year. Toaster pastries performance is the result of difficult comparisons due to the peanut butter innovations launched in 2013, and the timing of new introductions this year. We plan to introduce a new PB&J innovation in November, and believe that this business will return to growth. 32-------------------------------------------------------------------------------- Table of Contents Year-to-date underlying internal operating profit has declined 11.5% in U.S. Morning Foods as a result of unfavorable sales performance and increased brand-building investment which was partially offset by net cost deflation and continued discipline in overhead control. U.S. Snacks Year-to-date internal net sales for U.S. Snacks declined approximately 2.2% due to declines in our bars business, soft performance in our 100-calorie packs business, and a SKU rationalization initiative which negatively impacted sales. Crackers and savory snacks have posted growth resulting from innovations and improved in-store execution. Year-to-date underlying internal operating profit in U.S. Snacks declined 8.0% as a result of unfavorable sales performance and net cost inflation, which was partially offset by reduced brand-building investment and continued discipline in overhead control. U.S. Specialty Year-to-date internal net sales for U.S. Specialty declined by 1.5% as the business has been impacted negatively by weather early in the year, supply issues with a co-packer and an inventory deload as a customer shifted from warehouse to direct delivery. Excluding these issues, the business has performed well as a result of innovations and distribution gains. Year-to-date underlying internal operating profit in U.S. Specialty declined 0.3% as a result of unfavorable sales performance which was partially offset by net cost deflation. North America Other Year-to-date internal net sales for North America Other declined by 2.7% due primarily to the U.S. Frozen business reporting sales declines resulting partially from comparisons to strong prior-year growth behind innovation activity. Year-to-date underlying internal operating profit in North America Other declined 7.2% due to unfavorable sales performance which was partially offset by net cost deflation. Europe Year-to-date internal net sales for Europe declined by 0.5% due to softness in the cereal category in most developed markets, partially offset by general consumption growth realized in emerging markets. Savory snacks reported consumption and share growth during the year. Year-to-date underlying internal operating profit in Europe increased 3.0% due to net cost deflation which was partially offset by unfavorable sales performance, increased overhead investment, and increased brand-building investment. Latin America Year-to-date internal net sales for Latin America improved by 2.9% as strong price realization has more than offset sales declines in the first quarter resulting from the volume elasticity impact of the introduction of a new food tax in Mexico. Year-to-date underlying internal operating profit in Latin America improved 11.2% due to favorable sales performance which was partially offset by net cost inflation and increased overhead investment. Asia Pacific Year-to-date internal net sales for Asia Pacific improved by 1.3% due to sales growth in most markets. This was partially offset by weakness in the Australian cereal category and our performance in South Africa. In South Africa, we conducted construction work in the second quarter and it took longer to bring the plant back on line than expected. This impacted our ability to supply the market during the second quarter. It is important to note that the plant is producing once again. Year-to-date underlying internal operating profit in Asia Pacific declined 25.6% due to the weakness in the Australian cereal category, our performance in South Africa, increased brand-building investment, and net cost inflation. 33-------------------------------------------------------------------------------- Table of Contents Margin performance Margin performance for the quarter and year-to-date periods of 2014 versus 2013 is as follows: Change vs. prior Quarter 2014 2013 year (pts.) Reported gross margin (a) 35.5 % 39.0 % (3.5 ) Mark-to-market (COGS) (b) (1.9 )% - % (1.9 ) Restructuring and cost reduction activities (COGS) (c) (1.7 )% (0.3 )% (1.4 ) Underlying gross margin (d) 39.1 % 39.3 % (0.2 ) Reported SGA% (25.5 )% (25.4 )% (0.1 ) Mark-to-market (SGA) (b) - % - % - Restructuring and cost reduction activities (SGA) (c) (0.8 )% (0.4 )% (0.4 ) Underlying SGA% (d) (24.7 )% (25.0 )% 0.3 Reported operating margin 10.0 % 13.6 % (3.6 ) Mark-to-market (b) (1.9 )% - % (1.9 ) Restructuring and cost reduction activities (c) (2.5 )% (0.7 )% (1.8 ) Underlying operating margin (d) 14.4 % 14.3 % 0.1 Year-to-date 2014 2013 Reported gross margin (a) 38.0 % 38.3 % (0.3 ) Mark-to-market (COGS) (b) 0.4 % (0.5 )% 0.9 Restructuring and cost reduction activities (COGS) (c) (1.2 )% (0.2 )% (1.0 ) Underlying gross margin (d) 38.8 % 39.0 % (0.2 ) Reported SGA% (24.9 )% (24.3 )% (0.6 ) Mark-to-market (SGA) (b) - % - % - Restructuring and cost reduction activities (SGA) (c) (0.8 )% (0.2 )% (0.6 ) Underlying SGA% (d) (24.1 )% (24.1 )% - Reported operating margin 13.1 % 14.0 % (0.9 ) Mark-to-market (b) 0.4 % (0.5 )% 0.9 Restructuring and cost reduction activities (c) (2.0 )% (0.4 )% (1.6 ) Underlying operating margin (d) 14.7 % 14.9 % (0.2 ) (a) Reported gross margin as a percentage of net sales. Gross margin is equal to net sales less cost of goods sold. (b) Includes mark-to-market adjustments for pension plans and commodity contracts as reflected in cost of goods sold. Actuarial gains/losses for pension plans are recognized in the year they occur. A portion of these mark-to-market adjustments were capitalized as inventoriable cost at the end of 2013 and 2012. These amounts have been recognized in the first quarter of 2014 and 2013, respectively. During the third quarter of 2014, we remeasured the benefit obligation for an impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate. Mark-to-market adjustments for commodities reflect the changes in the fair value of contracts for the difference between contract and market prices for the underlying commodities. The resulting gains/losses are recognized in the quarter they occur. (c) Costs incurred related primarily to the execution of Project K, a global four-year efficiency and effectiveness program. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories. The 2013 periods presented have been recast to exclude all restructuring and cost reduction activities from underlying and comparable results. Previously, only costs associated with Project K were excluded from underlying and comparable results. (d) Underlying gross margin, underlying SGA%, and underlying operating margin are non-GAAP measures that exclude the impact of pension and commodity mark-to-market adjustments and restructuring and cost reduction activities. We believe the use of such non-GAAP measures provides increased transparency and assists in understanding our underlying operating performance. 34 -------------------------------------------------------------------------------- Table of Contents Underlying gross margin for the quarter declined 20 basis points due to unfavorable product mix, lower production volume resulting from soft sales performance, and increased integration costs, partially offset by net cost deflation. Underlying SG&A % improved 30 basis points as a result of decreased advertising investment, reduced integration costs and continued discipline in overhead control. On a year-to-date basis, underlying gross margin declined 20 basis points due to lower production volume resulting from soft sales performance and increased integration costs. Underlying SG&A % was flat as reduced integration costs and continued discipline in overhead control were offset by advertising and consumer promotion investment. 35 -------------------------------------------------------------------------------- Table of Contents Our underlying gross profit, underlying SG&A, and underlying operating profit measures are reconciled to the most comparable GAAP measure as follows: Quarter (dollars in millions) 2014 2013 Reported gross profit (a) $ 1,292 $ 1,450 Mark-to-market (COGS) (b) (66 ) 2 Restructuring and cost reduction activities (c) (64 ) (12 ) Underlying gross profit (d) $ 1,422 $ 1,460 Reported SGA $ 927 $ 946 Mark-to-market (SGA) (b) - - Restructuring and cost reduction activities (c) (28 ) (17 ) Underlying SGA (d) $ 899 $ 929 Reported operating profit $ 365 $ 504 Mark-to-market (b) (66 ) 2 Restructuring and cost reduction activities (c) (92 ) (29 ) Underlying operating profit (d) $ 523 $ 531 Year-to-date (dollars in millions) 2014 2013 Reported gross profit (a) $ 4,207 $ 4,320 Mark-to-market (COGS) (b) 38 (59 ) Restructuring and cost reduction activities (c) (120 ) (23 ) Underlying gross profit (d) $ 4,289 $ 4,402 Reported SGA $ 2,761 $ 2,743 Mark-to-market (SGA) (b) - - Restructuring and cost reduction activities (c) (104 ) (26 ) Underlying SGA (d) $ 2,657 $ 2,717 Reported operating profit $ 1,446 $ 1,577 Mark-to-market (b) 38 (59 ) Restructuring and cost reduction activities (c) (224 ) (49 ) Underlying operating profit (d) $ 1,632 $ 1,685 (a) Gross profit is equal to net sales less cost of goods sold. (b) Includes mark-to-market adjustments for pension plans and commodity contracts as reflected in cost of goods sold. Actuarial gains/losses for pension plans are recognized in the year they occur. A portion of these mark-to-market adjustments were capitalized as inventoriable cost at the end of 2013 and 2012. These amounts have been recognized in the first quarter of 2014 and 2013, respectively. During the third quarter of 2014, we remeasured the benefit obligation for an impacted other nonpension postretirement plan. The remeasurement resulted in a mark-to-market loss of $7 million primarily due to a lower discount rate. Mark-to-market adjustments for commodities reflect the changes in the fair value of contracts for the difference between contract and market prices for the underlying commodities. The resulting gains/losses are recognized in the quarter they occur. (c) Costs incurred related primarily to the execution of Project K, a global four-year efficiency and effectiveness program. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories. The 2013 periods presented have been recast to exclude all restructuring and cost reduction activities from underlying and comparable results. Previously, only costs associated with Project K were excluded from underlying and comparable results. (d) Underlying gross profit, underlying SGA, and underlying operating profit are non-GAAP measures that exclude the impact of pension and commodity mark-to-market adjustments and costs related to restructuring and cost reduction activities. We believe the use of these non-GAAP measures provide increased transparency and assist in understanding underlying operating performance. 36 -------------------------------------------------------------------------------- Table of Contents Foreign currency translation The reporting currency for our financial statements is the U.S. dollar. Certain of our assets, liabilities, expenses and revenues are denominated in currencies other than the U.S. dollar, including the euro, British pound, Australian dollar, Canadian dollar, Mexican peso, Venezuelan bolivar fuerte and Russian ruble. To prepare our consolidated financial statements, we must translate those assets, liabilities, expenses and revenues into U.S. dollars at the applicable exchange rates. As a result, increases and decreases in the value of the U.S. dollar against these other currencies will affect the value of these items in our consolidated financial statements, even if their value has not changed in their original currency. This could have a significant impact on our results if such increase or decrease in the value of the U.S. dollar is substantial. Restructuring and cost reduction activities We view continued spending on restructuring and cost reduction activities as part of our ongoing operating principles to provide greater visibility in achieving our 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. We have initiated a number of restructuring and cost reduction activities. The most recent and largest program that is currently active is Project K, a four-year efficiency and effectiveness program announced in November 2013. The program is expected to generate a significant amount of savings that will be invested in key strategic areas of focus for the business. We expect that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow. The focus of the program will be to strengthen existing businesses in core markets, increase growth in developing and emerging markets, and drive an increased level of value-added innovation. The program is expected to provide a number of benefits, including an optimized supply chain infrastructure, the implementation of global business services, and a new global focus on categories. During the quarter ended September 27, 2014, the Company recorded total charges of $92 million across all restructuring and cost reduction activities. The charges were comprised of $64 million being recorded in cost of goods sold (COGS) and $28 million recorded in selling, general and administrative (SGA) expense. During the year-to-date period ended September 27, 2014, the Company recorded total charges of $224 million across all restructuring and cost reduction activities. The charges were comprised of $120 million being recorded in COGS and $104 million recorded in SGA expense. During the quarter ended September 28, 2013 the Company recorded total charges of $29 million across all restructuring and cost reduction activities. The charges were comprised of $12 million being recorded in COGS and $17 million recorded in SGA expense. During the year-to-date period ended September 28, 2013 the Company recorded total charges of $49 million across all restructuring and cost reduction activities. The charges were comprised of $23 million being recorded in COGS and $26 million recorded in SGA expense. The tables below provide the details for charges across all restructuring and cost reduction activities incurred during the quarters and year-to-date periods ended September 27, 2014 and September 28, 2013 and program costs to date for programs currently active as of September 27, 2014. 37-------------------------------------------------------------------------------- Table of Contents Quarter ended Year-to-date period ended Program costs to date (millions) September 27, 2014 September 28, 2013 September 27, 2014 September 28, 2013 September 27, 2014Employee related costs $ 22 $ 12 $ 74 $ 17 $ 183 Asset related costs 6 - 16 5 25 Asset Impairment 21 - 21 - 87 Other costs 43 17 113 27 163 Total $ 92 $ 29 $ 224 $ 49 $ 458 Quarter ended Year-to-date period ended Program costs to date (millions) September 27, 2014 September 28, 2013 September 27, 2014 September 28, 2013 September 27, 2014 U.S. Morning Foods $ 15 $ 7 $ 41 $ 12 $ 151 U.S. Snacks 32 4 42 10 69 U.S. Specialty 1 1 2 3 7 North America Other 2 - 11 1 23 Europe 23 6 63 6 82 Latin America 1 3 6 3 13 Asia Pacific 11 1 22 7 46 Corporate 7 7 37 7 67 Total $ 92 $ 29 $ 224 $ 49 $ 458 For the quarter and year-to-date periods ended September 27, 2014 and September 28, 2013 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. We currently anticipate 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 expenditures, estimated to be $900 million to $1.1 billion. Cash expenditures, after tax and including incremental capital, of approximately $182 million were incurred in the year-to-date period ended September 27, 2014. Total cash expenditures, as defined, are expected to be approximately $300 to $400 million in 2014 and the balance of $600 to $700 million thereafter. We currently expect the charges will consist of asset-related costs totaling $450 to $500 million which will consist primarily of asset impairments, accelerated depreciation and other exit-related costs; employee-related costs totaling $425 to $475 million which will include severance, pension and other termination benefits; and other costs totaling $325 to $425 million which will consist primarily of charges related to the design and implementation of global business capabilities. A significant portion of other costs are the result of the implementation of global business service centers which are intended to simplify and standardize business support processes. Costs incurred to date related to Project K through September 27, 2014 totaled $419 million. We currently expect that total pre-tax charges will impact reportable segments as follows: U.S. Morning Foods (approximately 17%), U.S. Snacks (approximately 10%), U.S. Specialty (approximately 1%), North America Other (approximately 3%), Europe (approximately 12%), Latin America (approximately 3%), Asia-Pacific (approximately 6%), and Corporate (approximately 48%). A majority of the costs impacting Corporate relate to additional initiatives to be executed after 2014 that are currently not fully defined. As the development of these initiatives is completed, we will update its estimated costs by reportable segment as needed. We expect annual cost savings generated from Project K will be approximately $425 to $475 million by 2018, with approximately two-thirds of the cost savings to be realized in cost of goods sold. We realized $15 million of savings in 2013 and expect $60 to $70 million of savings in 2014, approximately 40% of which will come from cost of goods sold. Cost savings will be reinvested into the business through additional investments in advertising, in-store execution, and in the design and quality of our products. We will also invest in production capacity in developing and emerging markets, and in global category teams. As a result of Project K, we anticipate that capital spending will be impacted at least through the end of fiscal year 2015. Our current business model assumes capital spending to be approximately 3-4% of net sales annually. Through the end of fiscal year 2015, capital spending is expected to be approximately 4-5% as a result of Project K activities. 38-------------------------------------------------------------------------------- Table of Contents Due to the difference in timing between expected cash costs for the project and expected future cash savings, we anticipate funding the project through a combination of cash on hand and short-term debt. We also expect that the project will have an impact on our consolidated effective income tax rate during the execution of the project due to the timing of charges being taken in different tax jurisdictions. The impact of this project on our consolidated effective income tax rate will be excluded from the underlying income tax rate that will be disclosed on a quarterly basis. At September 27, 2014 reserves for all restructuring and cost reduction activities are reflected in the table below. A substantial portion of these reserves will be paid out in 2014 and 2015 related to severance payments and other costs. Employee Related Asset Asset Other (millions) Costs Impairment Related Costs Costs Total Liability as of December 28, 2013 $ 66 $ - $ - $ 12 $ 78 2014 restructuring charges 74 21 16 113 224 Cash payments (40 ) - (7 ) (116 ) (163 ) Non-cash charges and other 12 (21 ) (9 ) - (18 ) Liability as of September 27, 2014 $ 112 $ - $ - $ 9 $ 121 Interest expense For the quarter and year-to-date period ended September 27, 2014, interest expense was $54 million and $156 million, respectively, as compared to the quarter and year-to-date period ended September 28, 2013 with interest expense of $56 million and $177 million, respectively. The decrease in interest expense from the prior year is due primarily to the repayment of debt replaced by a combination of lower yield debt and commercial paper. For the full year 2014, we expect gross interest expense to be approximately $210 million, compared to 2013's full year interest expense of $235 million. Income taxes Our reported effective tax rates for the quarters ended September 27, 2014 and September 28, 2013 were 27.7% and 27.4%, respectively. Underlying effective tax rates for the quarters ended September 27, 2014 and September 28, 2013 were 28.5% and 27.7%, respectively. Refer to Note 8 within Notes to Consolidated Financial Statements for further information. For the full year 2014, we currently expect the underlying reported effective income tax rate to be approximately 29%. Fluctuations in foreign currency exchange rates could impact the expected effective income tax rate as it is dependent upon U.S. dollar earnings of foreign subsidiaries doing business in various countries with differing statutory rates. Additionally, the rate could be impacted if pending uncertain tax matters, including tax positions that could be affected by planning initiatives, are resolved more or less favorably than we currently expect. The following table sets forth a summary of our cash flows: Year-to-date period ended September 27, September 28, (millions) 2014 2013 Net cash provided by (used in): Operating activities $ 1,177 $ 1,389 Investing activities (348 ) (364 ) Financing activities (688 ) (982 ) Effect of exchange rates on cash and cash equivalents 12 (24 ) Net increase in cash and cash equivalents $ 153 $ 19 39 -------------------------------------------------------------------------------- Table of Contents Liquidity and capital resources Our principal source of liquidity is operating cash flows supplemented by borrowings for major acquisitions and other significant transactions. Our cash-generating capability is one of our fundamental strengths and provides us with substantial financial flexibility in meeting operating and investing needs. Operating activities The principal source of our operating cash flow is net earnings, meaning cash receipts from the sale of our products, net of costs to manufacture and market our products. Net cash provided by our operating activities for the year-to-date period ended September 27, 2014 amounted to $1,177 million, a decrease of $212 million compared to the same period in 2013. The decrease compared to the prior year is primarily due to an unfavorable year-over-year variance in after-tax Project K cash payments and other working capital items. Net cash provided by operating activities for the year-to-date periods ended September 27, 2014 and September 28, 2013 were negatively impacted by $118 million and $26 million of after-tax Project K cash payments, respectively. Our cash conversion cycle (defined as days of inventory, excluding inventoriable mark-to-market pensions and commodity costs, and trade receivables outstanding less days of trade payables outstanding, based on a trailing 12 month average) is relatively short, equating to approximately 30 days for each of the 12 month periods ended September 27, 2014 and September 28, 2013. Compared with the 12 month period ended September 28, 2013, the 2014 cash conversion cycle was relatively consistent for accounts payable. An unfavorable increase in accounts receivable was offset by a favorable decrease in inventory days outstanding. Our pension and other postretirement benefit plan contributions amounted to $44 million and $42 million for the year-to-date periods ended September 27, 2014 and September 28, 2013, respectively. For the full year 2014, we currently expect that our contributions to pension and other postretirement plans will total approximately $57 million. Plan funding strategies may be modified in response to our evaluation of tax deductibility, market conditions and competing investment alternatives. We measure cash flow as net cash provided by operating activities reduced by expenditures for property additions. We use this non-GAAP financial measure of cash flow to focus management and investors on the amount of cash available for debt repayment, dividend distributions, acquisition opportunities, and share repurchases. Our cash flow metric is reconciled to the most comparable GAAP measure, as follows: Year-to-date period ended September 27, September 28, Change versus (millions) 2014 2013 prior yearNet cash provided by operating activities $ 1,177 $ 1,389 (15.3 )% Additions to properties (355 ) (363 ) Cash flow $ 822 $ 1,026 (19.9 )% For the full-year 2014, we are projecting cash flow (as defined) to be approximately $1.0 billion to $1.1 billion. Investing activities Our net cash used in investing activities, primarily consisting of additions to properties, for the year-to-date period ended September 27, 2014 amounted to $348 million compared to $364 million in the same period of 2013. For the full-year 2014, we project capital spending to be between 4% and 5% of net sales. Financing activities Our net cash used in financing activities for the year-to-date period ended September 27, 2014 amounted to $688 million compared to $982 million in the same period of 2013. In March 2014, we retired an aggregate of $681 million of our 2020, 2022 and 2023 debt through a tender offer, which was primarily funded by commercial paper. In connection with the debt redemption, we incurred $1 million of interest expense, offset by $8 million of accelerated gains on interest rate hedges previously recorded in accumulated other comprehensive income, and recorded $5 million in Other Income, Expense (net), related to acceleration of deferred fees on the redeemed debt and fees related to the tender offer. These charges were included in cash flows for operating activities. 40-------------------------------------------------------------------------------- Table of Contents In May 2014, we issued Cdn. $300 million of long-term debt using the proceeds to retire Cdn. $300 million of long-term debt at maturity. In May 2014, we issued €500 million of long-term debt using the proceeds for general corporate purposes, which included repayment of a portion of our commercial paper. In February 2013, we issued long-term debt for net proceeds of approximately $645 million and in March 2013, retired $749 million of long-term debt at maturity. In December 2012, our board of directors approved a $300 million share repurchase program for 2013. In April 2013, the board of directors approved a $1 billion share repurchase program expiring in April 2014. In February 2014, the board of directors approved a new authorization to repurchase up to $1.5 billion in shares through December 2015. This authorization supersedes the April 2013 authorization and is intended to allow us to repurchase shares for general corporate purposes and to offset issuances for employee benefit programs. Actual repurchases could be different from our current expectations, as influenced by factors such as the impact of changes in our stock price and other competing priorities. In May 2013, we entered into an Accelerated Share Repurchase (ASR) Agreement with a financial institution counterparty and paid $355 million for the purchase of shares during the term of the Agreement which extended through August 2013. The total number of shares delivered upon settlement of the ASR was based upon the volume weighted average price of our company's stock over the term of the Agreement. Total purchases in 2014 and 2013, including shares initially delivered under the ASR were 11 million shares for $690 million and 9 million shares for $544 million, respectively. We paid cash dividends of $506 million in the year-to-date period ended September 27, 2014 compared to $486 million during the same period in 2013. The increase in dividends paid reflects our third quarter 2013 increase in the quarterly dividend to $.46 per common share, from the previous $.44 per common share. In October 2014, the board of directors declared a dividend of $.49 per common share, payable on December 15, 2014 to shareholders of record at the close of business on December 1, 2014. The dividend is consistent with our current plan to maintain our dividend pay-out between 40% and 50% of underlying net income. In February 2014, we entered into an unsecured five year credit agreement expiring in 2019, which allows us to borrow, in a revolving credit basis, up to $2.0 billion. This agreement replaced our unsecured four year credit agreement, which would have expired in March 2015. We are evaluating alternatives to refinance our existing notes payable on a longer-term basis. We are in compliance with all debt covenants. We continue to believe that we will be able to meet our interest and principal repayment obligations and maintain our debt covenants for the foreseeable future. We expect our access to public debt and commercial paper markets, along with operating cash flows, will be adequate to meet future operating, investing and financing needs, including the pursuit of selected acquisitions. Accounting standards to be adopted in future periods In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (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 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. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. 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. We will adopt the updated standard in the first quarter of 2017. We are currently evaluating the impact that implementing this ASU will have on our financial statements and disclosures, as well as whether we will use the retrospective or modified retrospective method of adoption. 41-------------------------------------------------------------------------------- Table of Contents Forward-looking statements This Report contains "forward-looking statements" with projections concerning, among other things, the Company's global growth and efficiency program (Project K), the integration of the Pringles® business, our strategy, financial principles, and plans; initiatives, improvements and growth; sales, gross margins, advertising, promotion, merchandising, brand building, operating profit, and earnings per share; innovation; investments; capital expenditures; costs, charges, rates of return, asset write-offs and expenditures and costs related to productivity or efficiency initiatives; workforce reductions, savings, the impact of accounting changes and significant accounting estimates; our ability to meet interest and debt principal repayment obligations; minimum contractual obligations; future common stock repurchases or debt reduction; effective income tax rate; cash flow and core working capital improvements; interest expense; commodity, and energy prices; and employee benefit plan costs and funding. Forward-looking statements include predictions of future results or activities and may contain the words "expects," "believes," "will," "can," "anticipates," "projects," "should," "estimates," "implies," "forecasted," or words or phrases of similar meaning. For example, forward-looking statements are found in Item 1 and in several sections of Management's Discussion and Analysis. Our actual results or activities may differ materially from these predictions. Our future results could be affected by a variety of factors, including: • the ability to implement Project K as planned, whether the expected amount of costs associated with Project K will differ from forecasts, whether the Company will be able to realize the anticipated benefits from Project K in the amounts and times expected; • the ability to realize the anticipated benefits and synergies from the Pringles acquisition in the amounts and at the times expected; • the impact of competitive conditions; • the effectiveness of pricing, advertising, and promotional programs; • the success of innovation, renovation and new product introductions; • the recoverability of the carrying value of goodwill and other intangibles; • the success of productivity improvements and business transitions; • commodity and energy prices; • labor costs; • disruptions or inefficiencies in supply chain; • the availability of and interest rates on short-term and long-term financing; • actual market performance of benefit plan trust investments; • the levels of spending on systems initiatives, properties, business opportunities, integration of acquired businesses, and other general and administrative costs; • changes in consumer behavior and preferences; • the effect of U.S. and foreign economic conditions on items such as interest rates, statutory tax rates, currency conversion and availability; • legal and regulatory factors including changes in food safety, advertising and labeling laws and regulations; • the ultimate impact of product recalls; • business disruption or other losses from natural disasters, war, terrorist acts, or political unrest; and, • the risks and uncertainties described herein under Part II, Item 1A. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to publicly update them. 42-------------------------------------------------------------------------------- Table of Contents |