Edgar Filing: KELLOGG CO

10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

For the quarterly period ended June 28, 2014

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

For the transition period from to

Commission file number 1-4171

KELLOGG COMPANY


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

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

Registrant’s telephone number: 269-961-2000

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

Yes x No ¨

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

Yes x No ¨

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


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

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

Yes ¨ No x

Common Stock outstanding as of July 26, 2014 — 360,122,788 shares

KELLOGG COMPANY

INDEX


	Page
PART I — Financial Information

Item 1:
Financial Statements

Consolidated Balance Sheet — June 28, 2014 and December 28, 2013		3

Consolidated Statement of Income — quarter and year-to-date periods ended June 28, 2014 and June 29, 2013		4

Consolidated Statement of Comprehensive Income – quarter and year-to-date periods ended June 28, 2014 and June 29, 2013		5

Consolidated Statement of Equity — year ended December 28, 2013 and year-to-date period ended June 28, 2014		6

Consolidated Statement of Cash Flows — year-to-date periods ended June 28, 2014 and June 29, 2013		7

Notes to Consolidated Financial Statements		8

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

Item 3:
Quantitative and Qualitative Disclosures about Market Risk		42

Item 4:
Controls and Procedures		43

PART II — Other Information

Item 1A:
Risk Factors		44

Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds		44

Item 6:
Exhibits		44

Signatures		45

Exhibit Index		46

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED BALANCE SHEET

(millions, except per share data)


	June 28, 2014 (unaudited)			December 28, 2013 *
Current assets
Cash and cash equivalents	$	290		$	273
Accounts receivable, net		1,544			1,424
Inventories:
Raw materials and supplies		345			319
Finished goods and materials in process		958			929
Deferred income taxes		169			195
Other prepaid assets		185			127

Total current assets		3,491			3,267

Property, net of accumulated depreciation of $5,719 and $5,501		3,879			3,856
Goodwill		5,055			5,051
Other intangibles, net of accumulated amortization of $66 and $62		2,361			2,367
Pension		501			419
Other assets		526			514


Total assets	$	15,813		$	15,474



Current liabilities
Current maturities of long-term debt	$	607		$	289
Notes payable		858			739
Accounts payable		1,462			1,432
Accrued advertising and promotion		487			476
Accrued income taxes		39			69
Accrued salaries and wages		287			327
Other current liabilities		555			503


Total current liabilities		4,295			3,835

Long-term debt		6,029			6,330
Deferred income taxes		917			928
Pension liability		269			277
Nonpension postretirement benefits		69			68
Other liabilities		421			429

Commitments and contingencies

Equity
Common stock, $.25 par value		105			105
Capital in excess of par value		653			626
Retained earnings		7,113			6,749
Treasury stock, at cost		(3,191	)		(2,999	)
Accumulated other comprehensive income (loss)		(928	)		(936	)


Total Kellogg Company equity		3,752			3,545

Noncontrolling interests		61			62

Total equity		3,813			3,607

Total liabilities and equity	$	15,813		$	15,474

*	Condensed from audited financial statements.

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME

(millions, except per share data)


	Quarter ended						Year-to-date period ended
	June 28,			June 29,			June 28,			June 29,
(Results are unaudited)	2014			2013			2014			2013
Net sales	$	3,685		$	3,714		$	7,427		$	7,575

Cost of goods sold		2,274			2,237			4,512			4,705
Selling, general and administrative expense		944			907			1,834			1,797


Operating profit		467			570			1,081			1,073

Interest expense		50			61			102			121
Other income (expense), net		3			(5	)		13			(12	)


Income before income taxes		420			504			992			940
Income taxes		122			150			287			274
Earnings (loss) from joint ventures		(3	)		(2	)		(4	)		(3	)

Net income	$	295		$	352		$	701		$	663

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

Net income attributable to Kellogg Company	$	295		$	352		$	701		$	663



Per share amounts:
Basic	$	0.82		$	0.96		$	1.95		$	1.82
Diluted	$	0.82		$	0.96		$	1.94		$	1.81

Dividends per share	$	0.46		$	0.44		$	0.92		$	0.88


Average shares outstanding:
Basic		359			364			360			364

Diluted		362			367			362			366


Actual shares outstanding at period end								360			362

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(millions)


	Quarter ended June 28, 2014						Year-to-date period ended June 28, 2014
(Results are unaudited)	Pre-tax amount		Tax (expense) benefit		After-tax amount		Pre-tax amount		Tax (expense) benefit		After-tax amount

Net income					$	295					$	701
Other comprehensive income (loss):
Foreign currency translation adjustments	$	30	$	—		30	$	33	$	—		33
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		(23)		7		(16)		(24)		7		(17)
Reclassification to net income		(1)		—		(1)		(11)		3		(8)
Postretirement and postemployment benefits:
Amounts arising during the period:
Prior service credit (cost)		(9)		3		(6)		(9)		3		(6)
Reclassification to net income:
Net experience loss		1		—		1		2		—		2
Prior service cost		4		(1)		3		6		(2)		4

Other comprehensive income (loss)	$	2	$	9	$	11	$	(3)	$	11	$	8

Comprehensive income					$	306					$	709



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

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

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

Comprehensive income					$	303					$	586

Refer to Notes to Consolidated Financial Statements.

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			Total comprehensive income (loss)
(unaudited)	shares		amount		Capital in excess of par value		Retained earnings			shares			amount			Accumulated other comprehensive income (loss)			Total Kellogg Company equity			Non- controlling interests			Total equity			Total comprehensive income (loss)
Balance, December 29, 2012		420	$	105	$	573	$	5,615			58		$	(2,943	)	$	(946	)	$	2,404		$	61		$	2,465
Common stock repurchases											9			(544	)					(544	)					(544	)
Net income								1,807												1,807			1			1,808		$	1,808
Dividends								(653	)											(653	)					(653	)
Other comprehensive income																	10			10						10			10
Stock compensation						28														28						28
Stock options exercised and other						25		(20	)		(10	)		488						493						493

Balance, December 28, 2013		420	$	105	$	626	$	6,749			57		$	(2,999	)	$	(936	)	$	3,545		$	62		$	3,607		$	1,818
Common stock repurchases											6			(329	)					(329	)					(329	)
Net income								701												701						701			701
Dividends								(330	)											(330	)		(1	)		(331	)
Other comprehensive income																	8			8						8			8
Stock compensation						21														21						21
Stock options exercised and other						6		(7	)		(3	)		137						136						136

Balance, June 28, 2014		420	$	105	$	653	$	7,113			60		$	(3,191	)	$	(928	)	$	3,752		$	61		$	3,813		$	709

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS

(millions)


	Year-to-date period ended
	June 28,			June 29,
(unaudited)	2014			2013
Operating activities
Net income	$	701		$	663
Adjustments to reconcile net income to operating cash flows:
Depreciation and amortization		235			226
Postretirement benefit plan expense (benefit)		(45	)		(8	)
Deferred income taxes		18			9
Other		18			60
Postretirement benefit plan contributions		(37	)		(36	)
Changes in operating assets and liabilities, net of acquisitions:
Trade receivables		(136	)		(112	)
Inventories		(55	)		91
Accounts payable		30			(38	)
Accrued income taxes		7			3
Accrued interest expense		(8	)		(6	)
Accrued and prepaid advertising, promotion and trade allowances		(12	)		(53	)
Accrued salaries and wages		(39	)		(47	)
All other current assets and liabilities		(23	)		(47	)


Net cash provided by (used in) operating activities		654			705


Investing activities
Additions to properties		(226	)		(238	)
Other		—			(1	)


Net cash provided by (used in) investing activities		(226	)		(239	)


Financing activities
Net issuances of notes payable		118			71
Issuances of long-term debt		952			645
Reductions of long-term debt		(957	)		(760	)
Net issuances of common stock		133			408
Common stock repurchases		(329	)		(544	)
Cash dividends		(331	)		(320	)
Other		6			20


Net cash provided by (used in) financing activities		(408	)		(480	)


Effect of exchange rate changes on cash and cash equivalents		(3	)		(5	)


Increase (decrease) in cash and cash equivalents		17			(19	)
Cash and cash equivalents at beginning of period		273			281


Cash and cash equivalents at end of period	$	290		$	262

Refer to Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements

for the quarter ended June 28, 2014 (unaudited)

Note 1 Accounting policies

Basis of presentation

The unaudited interim financial information of Kellogg Company (the Company) included in this report reflects normal recurring adjustments that management believes are necessary for a fair statement of the results of operations, comprehensive income, financial position, equity and cash flows for the periods presented. This interim information should be read in conjunction with the financial statements and accompanying footnotes within the Company’s 2013 Annual Report on Form 10-K.

The condensed balance sheet data at December 28, 2013 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the quarterly period ended June 28, 2014 are not necessarily indicative of the results to be expected for other interim periods or the full year.

Accounts payable

Beginning in 2014, 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 to designated third-party financial institutions, payment obligations of the Company. 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 pricing, payment terms or vendor funding, created by facilitating suppliers’ ability to sell receivables, 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 June 28, 2014, $142 million of the Company’s outstanding payment obligations had been placed in the accounts payable tracking system, and participating suppliers had sold $114 million of those payment obligations to participating financial institutions.

New accounting standards

Presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. In July 2013, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance on financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU is expected to eliminate diversity in practice resulting from lack of previously existing guidance. It applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date. The Company adopted the revised guidance on a prospective basis at the beginning of its 2014 fiscal year, with no significant impact to the Consolidated Financial Statements.

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. The Company will adopt the updated standard in the first quarter of 2017. 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 Goodwill and other intangible assets

Changes in the carrying amount of goodwill for the year-to-date period ended June 28, 2014, are presented in the following table:

Carrying amount of goodwill


(millions)	U.S. Morning Foods		U.S. Snacks		U.S. Specialty		North America Other		Europe		Latin America		Asia Pacific		Consoli- dated
December 28, 2013	$	133	$	3,779	$	82	$	278	$	452	$	89	$	238	$	5,051
Currency translation adjustment		—		—		—		1		—		—		3		4
June 28, 2014	$	133	$	3,779	$	82	$	279	$	452	$	89	$	241	$	5,055

Intangible assets subject to amortization

(millions)


Gross carrying amount	U.S. Morning Foods		U.S. Snacks			U.S. Specialty		North America Other		Europe			Latin America		Asia Pacific		Consoli- dated
December 28, 2013	$	28	$	70		$	—	$	5	$	44		$	7	$	10	$	164
Currency translation adjustment		—		—			—		—		—			—		—		—

June 28, 2014	$	28	$	70		$	—	$	5	$	44		$	7	$	10	$	164



Accumulated Amortization

December 28, 2013	$	28	$	16		$	—	$	4	$	6		$	7	$	1	$	62
Amortization		—		2			—		—		2			—		—		4
June 28, 2014	$	28	$	18		$	—	$	4	$	8		$	7	$	1	$	66



Intangible assets subject to amortization, net

December 28, 2013	$	—	$	54		$	—	$	1	$	38		$	—	$	9	$	102
Currency translation adjustment		—		—			—		—		—			—		—		—
Amortization		—		(2	)		—		—		(2	)		—		—		(4	)
June 28, 2014	$	—	$	52		$	—	$	1	$	36		$	—	$	9	$	98

For intangible assets in the preceding table, amortization was $4 million for the current year-to-date period ended June 28, 2014, compared to $3 million for the prior year-to-date period ended June 29, 2013. The currently estimated aggregate annual amortization expense for full-year 2014 and each of the four succeeding fiscal years is approximately $9 million.

Intangible assets not subject to amortization


(millions)	U.S. Morning Foods		U.S. Snacks		U.S. Specialty		North America Other		Europe			Latin America		Asia Pacific		Consoli- dated

December 28, 2013	$	63	$	1,625	$	—	$	95	$	482		$	—	$	—	$	2,265
Currency translation adjustment		—		—		—		—		(2	)		—		—		(2	)

June 28, 2014	$	63	$	1,625	$	—	$	95	$	480		$	—	$	—	$	2,263

Note 3 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.

The Company has 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. The Company expects that this investment will drive future growth in revenues, gross margin, operating profit, and cash flow.

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

During the quarter ended June 28, 2014, the Company recorded total charges of $78 million across all restructuring and cost reduction activities. The charges were comprised of $31 million being recorded in cost of goods sold (COGS) and $47 million recorded in selling, general and administrative (SGA) expense. During the year-to-date period ended June 28, 2014, the Company recorded total charges of $132 million across all restructuring and cost reduction activities. The charges were comprised of $56 million being recorded in COGS and $76 million recorded in SGA expense.

During the quarter ended June 29, 2013 the Company recorded total charges of $7 million across all restructuring and cost reduction activities. The charges were comprised of $3 million being recorded in COGS and $4 million recorded in SGA expense. During the year-to-date period ended June 29, 2013 the Company recorded total charges of $20 million across all restructuring and cost reduction activities. The charges were comprised of $11 million being recorded in COGS and $9 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 June 28, 2014 and June 29, 2013 and program costs to date for programs currently active as of June 28, 2014.


	Quarter ended				Year-to-date period ended				Program costs to date
(millions)	June 28, 2014		June 29, 2013		June 28, 2014		June 29, 2013		June 28, 2014
Employee related costs	$	35	$	1	$	52	$	5	$	161
Asset related costs		7		—		10		5		19
Asset Impairment		—		—		—		—		66
Other costs		36		6		70		10		128

Total	$	78	$	7	$	132	$	20	$	374



	Quarter ended				Year-to-date period ended				Program costs to date
(millions)	June 28, 2014		June 29, 2013		June 28, 2014		June 29, 2013		June 28, 2014
U.S. Morning Foods	$	15	$	2	$	26	$	5	$	136
U.S. Snacks		3		3		10		6		37
U.S. Specialty		—		1		1		2		6
North America Other		6		1		9		1		21
Europe		28		—		40		—		67
Latin America		1		—		5		—		12
Asia Pacific		5		—		11		6		35
Corporate		20		—		30		—		60

Total	$	78	$	7	$	132	$	20	$	374

For the quarter and year-to-date periods ended June 28, 2014, and June 29, 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.

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 expenditures, estimated to be $900 million to $1.1 billion. The Company currently expects the charges will consist of asset-related costs totaling $450 to $500 million which will consist primarily of asset impairments, 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.

The Company currently expects 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 10%), Latin America (approximately 2%), Asia-Pacific (approximately 6%), and Corporate (approximately 51%). A majority of the costs impacting Corporate relate to additional initiatives to be executed after 2014 that are currently not fully defined. As the development of these initiatives is completed, the Company will update its estimated costs by reportable segment as needed.

At June 28, 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.


(millions)	Employee Related Costs			Asset Impairment		Asset Related Costs			Other Costs			Total
Liability as of December 28, 2013	$	66		$	—	$	—		$	12		$	78
2014 restructuring charges		52			—		10			70			132
Cash payments		(15	)		—		(3	)		(70	)		(88	)
Non-cash charges and other		—			—		(7	)		—			(7	)

Liability as of June 28, 2014	$	103		$	—	$	—		$	12		$	115

Note 4 Equity

Earnings per share

Basic earnings per share is determined by dividing net income attributable to Kellogg Company by the weighted average number of common shares outstanding during the period. Diluted earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares consist principally of employee stock options issued by the Company, and to a lesser extent, certain contingently issuable performance shares. Basic earnings per share is reconciled to diluted earnings per share in the following tables. There were zero and 4 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended June 28, 2014, respectively. There were 6 million and 4 million anti-dilutive potential common shares excluded from the reconciliation for the quarter and year-to-date periods ended June 29, 2013, respectively.

Quarters ended June 28, 2014 and June 29, 2013:


(millions, except per share data)	Net income attributable to Kellogg Company		Average shares outstanding		Earnings per share
2014
Basic	$	295		359	$	0.82
Dilutive potential common shares				3		—
Diluted	$	295		362	$	0.82

2013
Basic	$	352		364	$	0.96
Dilutive potential common shares				3		—

Diluted	$	352		367	$	0.96

Year-to-date periods ended June 28, 2014 and June 29, 2013:


(millions, except per share data)	Net income attributable to Kellogg Company		Average shares outstanding		Earnings per share
2014
Basic	$	701		360	$	1.95
Dilutive potential common shares				2		(0.01	)
Diluted	$	701		362	$	1.94

2013
Basic	$	663		364	$	1.82
Dilutive potential common shares				2		(0.01	)

Diluted	$	663		366	$	1.81

In February 2014, the Company’s board of directors approved a share repurchase program authorizing the repurchase of up to $1.5 billion of common stock through December 2015. This authorization supersedes the April 2013 authorization and is intended to allow the Company to repurchase shares for general corporate purposes and to offset issuances for employee benefit programs.

During the year-to-date period ended June 28, 2014, the Company repurchased approximately 6 million shares of common stock for a total of $329 million. During the year-to-date period ended June 29, 2013, the Company repurchased approximately 8 million shares of common stock for a total of $508 million.

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.

Prior service cost arising during the period consists primarily of post-employment benefits provided to certain employees previously not covered by a plan.


	Quarter ended June 28, 2014						Year-to-date period ended June 28, 2014
(millions)	Pre-tax amount		Tax (expense) benefit		After-tax amount		Pre-tax amount		Tax (expense) benefit		After-tax amount

Net income					$	295					$	701
Other comprehensive income (loss):
Foreign currency translation adjustments	$	30	$	—		30	$	33	$	—		33
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges		(23)		7		(16)		(24)		7		(17)
Reclassification to net income		(1)		—		(1)		(11)		3		(8)
Postretirement and postemployment benefits:
Amounts arising during the period:
Prior service credit (cost)		(9)		3		(6)		(9)		3		(6)
Reclassification to net income:
Net experience loss		1		—		1		2		—		2
Prior service cost		4		(1)		3		6		(2)		4

Other comprehensive income (loss)	$	2	$	9	$	11	$	(3)	$	11	$	8

Comprehensive income					$	306					$	709



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

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

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

Comprehensive income					$	303					$	586

Reclassifications out of Accumulated Other Comprehensive Income (AOCI) for the quarter and year-to-date periods ended June 28, 2014 consisted of the following:


(millions)
Details about AOCI components	Amount reclassified from AOCI						Line item impacted within Income Statement
	Quarter ended June 28, 2014			Year-to-date period ended June 28, 2014
(Gain)loss on cash flow hedges:
Foreign currency exchange contracts	$	(1	)	$	(2	)	COGS
Foreign currency exchange contracts		(2	)		(3	)	SGA
Interest rate contracts		—			(9	)	Interest expense
Commodity contracts		2			3		COGS

	$	(1	)	$	(11	)	Total before tax
		—			3		Tax (expense) benefit

	$	(1	)	$	(8	)	Net of tax

Amortization of postretirement and postemployment benefits:
Net experience loss	$	1		$	2		See Note 7 for further details
Prior service cost		4			6		See Note 7 for further details

	$	5		$	8		Total before tax
		(1	)		(2	)	Tax (expense) benefit

	$	4		$	6		Net of tax

Total reclassifications	$	3		$	(2	)	Net of tax

Reclassifications out of AOCI for the quarter and year-to-date periods ended June 29, 2013 consisted of the following:


(millions)
Details about AOCI components	Amount reclassified from AOCI						Line item impacted within Income Statement
	Quarter ended June 29, 2013			Year-to-date period ended June 29, 2013
(Gain) loss on cash flow hedges:
Foreign currency exchange contracts	$	(3	)	$	(5	)	COGS
Interest rate contracts		(1	)		(2	)	Interest expense
Commodity contracts		2			5		COGS

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

	$	(2	)	$	(2	)	Net of tax

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

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

	$	3		$	7		Net of tax

Total reclassifications	$	1		$	5		Net of tax

Accumulated other comprehensive income (loss) as of June 28, 2014 and December 28, 2013 consisted of the following:


(millions)	June 28, 2014			December 28, 2013
Foreign currency translation adjustments	$	(823	)	$	(856	)
Cash flow hedges — unrealized net gain (loss)		(24	)		1
Postretirement and postemployment benefits:
Net experience loss		(13	)		(15	)
Prior service cost		(68	)		(66	)

Total accumulated other comprehensive income (loss)	$	(928	)	$	(936	)

Note 5 Debt

The following table presents the components of notes payable at June 28, 2014 and December 28, 2013:


	June 28, 2014					December 28, 2013
(millions)	Principal amount		Effective interest rate			Principal amount		Effective interest rate
U.S. commercial paper	$	391		0.19	%	$	249		0.22	%
Europe commercial paper		414		0.36			437		0.23
Bank borrowings		53					53

Total	$	858				$	739

In May 2014, the Company issued €500 million (approximately $678 million USD at June 28, 2014, which reflects the discount and translation adjustments) of seven-year 1.75% Euro Notes due 2021, using the proceeds from these Notes for general corporate purposes, which included repayment of a portion of the Company’s 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.

In May 2014, the Company issued Cdn. $300 million (approximately $279 million USD at June 28, 2014, which reflects the discount and translation adjustments) of three-year 2.05% Canadian Dollar Notes due 2017, using the proceeds from these Notes, together with cash on hand, to repay the Company’s Cdn. $300 million, 2.10% Notes due May 22, 2014 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.

In February 2014, the Company entered into an unsecured Five-Year Credit Agreement to replace its existing unsecured Four-Year Credit Agreement, which would have expired in March 2015. The Five-Year Credit Agreement allows the Company to borrow, on a revolving credit basis, up to $2.0 billion, which includes the ability to obtain letters of credit in an aggregate stated amount not to exceed $75 million and swingline loans in aggregate principal amounts up to $200 million in U.S. dollars and $400 million in Euros. The agreement contains customary covenants and warranties, including specified restrictions on indebtedness, liens and a specified interest coverage ratio. If an event of default occurs, then, to the extent permitted, the administrative agent may terminate the commitments under the credit facility, accelerate any outstanding loans under the agreement, and demand the deposit of cash collateral equal to the lender’s letter of credit exposure plus interest.

In March 2014, the Company redeemed $150 million of its 4.0% U.S. Dollar Notes due 2020, $342 million of its 3.125% U.S. Dollar Debentures due 2022 and $189 million of its 2.75% U.S. Dollar Notes due 2023. In connection with the debt redemption, the Company 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 incurred $5 million of expense, recorded in Other Income, Expense (net), related to acceleration of fees on the redeemed debt and fees related to the tender offer.

The Company has entered into interest rate swaps with notional amounts totaling $2.4 billion, which effectively converts a portion of the associated U.S. Dollar Notes from fixed rate to floating rate obligations. These derivative instruments are designated as fair value hedges. The effective interest rates on debt obligations resulting from the Company’s interest rate swaps as of June 28, 2014 were as follows: (a) seven-year 4.45% U.S. Dollar Notes due 2016 – 3.43%; (b) five-year

1.875% U.S. Dollar Notes due 2016 – 0.97%; (c) five-year 1.75% U.S. Dollar Notes due 2017 - 1.31%; (d) seven-year 3.25% U.S. Dollar Notes due 2018 – 1.83%; (e) ten-year 4.15% U.S. Dollar Notes due 2019 - 2.71%; (f) ten-year 4.00% U.S. Dollar Notes due 2020 - 2.80%; (g) ten-year 3.125% U.S. Dollar Notes due 2022 - 2.28%.

Note 6 Stock compensation

The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, and to a lesser extent, executive performance shares, restricted stock units and restricted stock grants. The Company also sponsors a discounted stock purchase plan in the United States and matching-grant programs in several international locations. Additionally, the Company awards restricted stock to its outside directors. The interim information below should be read in conjunction with the disclosures included within the stock compensation footnote of the Company’s 2013 Annual Report on Form 10-K.

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


	Quarter ended				Year-to-date period ended
(millions)	June 28, 2014		June 29, 2013		June 28, 2014		June 29, 2013
Pre-tax compensation expense	$	14	$	12	$	28	$	21

Related income tax benefit	$	5	$	5	$	10	$	8

As of June 28, 2014, total stock-based compensation cost related to non-vested awards not yet recognized was $67 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 June 28, 2014 and June 29, 2013, 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 2013 Annual Report on Form 10-K.

Year-to-date period ended June 28, 2014:


						Weighted-
				Weighted-		average		Aggregate
				average		remaining		intrinsic
	Shares			exercise		contractual		value
Employee and director stock options	(millions)			price		term (yrs.)		(millions)

Outstanding, beginning of period		20		$	54
Granted		6			60
Exercised		(2	)		50
Forfeitures and expirations		(1	)		57

Outstanding, end of period		23		$	55		7.5	$	209

Exercisable, end of period		11		$	52		6.0	$	145

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


						Weighted-
				Weighted-		average		Aggregate
				average		remaining		intrinsic
	Shares			exercise		contractual		value
Employee and director stock options	(millions)			price		term (yrs.)		(millions)

Outstanding, beginning of period		25		$	50
Granted		6			60
Exercised		(9	)		48
Forfeitures and expirations		(1	)		54

Outstanding, end of period		21		$	53		7.4	$	231

Exercisable, end of period		10		$	50		5.8	$	150

The weighted-average fair value of options granted was $6.70 per share and $5.92 per share for the year-to-date periods ended June 28, 2014 and June 29, 2013, respectively. The fair value was estimated using the following assumptions:


	Weighted- average expected volatility			Weighted- average expected term (years)		Weighted- average risk-free interest rate			Dividend yield
Grants within the year-to-date period ended June 28, 2014:		15	%		7.34		2.35	%		3.00	%
Grants within the year-to-date period ended June 29, 2013:		15	%		7.44		1.49	%		2.90	%

The total intrinsic value of options exercised was $33 million and $117 million for the year-to-date periods ended June 28, 2014 and June 29, 2013, respectively.

Performance shares

In the first quarter of 2014, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year operating profit and internal net sales growth targets are achieved.

The 2014 target grant currently corresponds to approximately 227,000 shares, with a grant-date fair value of $54 per share. The actual number of shares issued on the vesting date could range from 0 to 200% of target, depending on actual performance achieved. Based on the market price of the Company’s common stock at June 28, 2014, the maximum future value that could be awarded to employees on the vesting date for all outstanding performance share awards was as follows:


(millions)	June 28, 2014
2012 Award	$	23
2013 Award	$	26
2014 Award	$	30

The 2011 performance share award, payable in stock, was settled at 60% of target in February 2014 for a total dollar equivalent of $3 million.

Note 7 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 2013 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)	June 28, 2014			June 29, 2013			June 28, 2014			June 29, 2013
Service cost	$	27		$	34		$	53		$	68
Interest cost		56			50			113			100
Expected return on plan assets		(105	)		(89	)		(209	)		(179	)
Amortization of unrecognized prior service cost		4			4			7			8

Total pension expense (income)	$	(18	)	$	(1	)	$	(36	)	$	(3	)



*Other nonpension postretirement*
	Quarter ended						Year-to-date period ended
(millions)	June 28, 2014			June 29, 2013			June 28, 2014			June 29, 2013
Service cost	$	7		$	8		$	14		$	17
Interest cost		13			12			27			24
Expected return on plan assets		(25	)		(22	)		(49	)		(44	)
Amortization of unrecognized prior service cost		—			(1	)		(1	)		(2	)

Total postretirement benefit expense (income)	$	(5	)	$	(3	)	$	(9	)	$	(5	)



*Postemployment*
	Quarter ended						Year-to-date period ended
(millions)	June 28, 2014			June 29, 2013			June 28, 2014			June 29, 2013
Service cost	$	2		$	1		$	4		$	3
Interest cost		1			1			2			2
Recognized net loss		1			1			2			3

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

Company contributions to employee benefit plans are summarized as follows:


			Nonpension
(millions)	Pension		postretirement		Total
Quarter ended:
June 28, 2014	$	5	$	4	$	9
June 29, 2013	$	1	$	4	$	5

Year-to-date period ended:
June 28, 2014	$	29	$	8	$	37
June 29, 2013	$	28	$	8	$	36

Full year:
Fiscal year 2014 (projected)	$	43	$	14	$	57
Fiscal year 2013 (actual)	$	34	$	14	$	48

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

Note 8 Income taxes

The consolidated effective tax rate for the quarters ended June 28, 2014 and June 29, 2013 were 29.0% and 29.9%, respectively. The consolidated effective tax rates for the year-to-date periods ended June 28, 2014 and June 29, 2013 were 28.9% and 29.2%, respectively.

As of June 28, 2014, the Company classified $5 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 is comprised of the current liability balance which is expected to be settled within one year, offset by approximately $8

million of projected additions related primarily to ongoing intercompany transfer pricing activity. Management is currently unaware of any issues under review that could result in significant additional payments, accruals or other material deviation in this estimate.

Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the year-to-date period ended June 28, 2014; $62 million of this total represents the amount that, if recognized, would affect the Company’s effective income tax rate in future periods.


(millions)
December 28, 2013	$	79
Tax positions related to current year:
Additions		5
Reductions		—
Tax positions related to prior years:
Additions		4
Reductions		(2	)
Settlements		1

June 28, 2014	$	87

For the year-to-date period ended June 28, 2014 the Company recognized an increase of $1 million for tax-related interest and penalties. The Company recognized no cash settlements during the current quarter. The accrual balance was $18 million at June 28, 2014.

Note 9 Derivative instruments and fair value measurements

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

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

Total notional amounts of the Company’s derivative instruments as of June 28, 2014 and December 28, 2013 were as follows:


	June 28,		December 28,
(millions)	2014		2013
Foreign currency exchange contracts	$	652	$	517
Interest rate contracts		3,082		2,400
Commodity contracts		511		361

Total	$	4,245	$	3,278

Following is a description of each category in the fair value hierarchy and the financial assets and liabilities of the Company that were included in each category at June 28, 2014 and December 28, 2013, measured on a recurring basis.

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

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

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

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

Level 3 – Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability. The Company did not have any level 3 financial assets or liabilities as of June 28, 2014 or December 28, 2013.

The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of June 28, 2014 and December 28, 2013:

Derivatives designated as hedging instruments


	June 28, 2014								December 28, 2013
(millions)	Level 1		Level 2			Total			Level 1		Level 2			Total
Assets:
Foreign currency exchange contracts:
Other prepaid assets	$	—	$	4		$	4		$	—	$	7		$	7

Total assets	$	—	$	4		$	4		$	—	$	7		$	7


Liabilities:
Foreign currency exchange contracts:
Other current liabilities	$	—	$	(14	)	$	(14	)	$	—	$	(8	)	$	(8	)
Interest rate contracts:
Other current liabilities		—		(4	)		(4	)		—		—			—
Other liabilities (a)		—		(29	)		(29	)		—		(59	)		(59	)
Commodity contracts:
Other current liabilities		—		(9	)		(9	)		—		(9	)		(9	)
Other liabilities		—		(14	)		(14	)		—		(19	)		(19	)

Total liabilities	$	—	$	(70	)	$	(70	)	$	—	$	(95	)	$	(95	)

(a)	The fair value of the related hedged portion of the Company’s long-term debt, a level 2 liability, was $2.5 billion as of June 28, 2014 and December 28, 2013.

Derivatives not designated as hedging instruments


	June 28, 2014								December 28, 2013
(millions)	Level 1			Level 2		Total			Level 1			Level 2		Total
Assets:
Commodity contracts:
Other prepaid assets	$	6		$	—	$	6		$	3		$	—	$	3

Total assets	$	6		$	—	$	6		$	3		$	—	$	3


Liabilities:
Commodity contracts:
Other current liabilities	$	(9	)	$	—	$	(9	)	$	(7	)	$	—	$	(7	)

Total liabilities	$	(9	)	$	—	$	(9	)	$	(7	)	$	—	$	(7	)

The Company has elected to not 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 June 28, 2014 and December 28, 2013 would be adjusted as detailed in the following table:


As of June 28, 2014:
				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	$	10		$	(10	)	$	—	$	—
Total liability derivatives	$	(79	)	$	10		$	27	$	(42	)



As of December 28, 2013:
				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	$	10		$	(10	)	$	—	$	—
Total liability derivatives	$	(102	)	$	10		$	21	$	(71	)

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the quarters ended June 28, 2014 and June 29, 2013 was as follows:

Derivatives in fair value hedging relationships


(millions)	Location of gain (loss) recognized in income	Gain (loss) recognized in income (a)
		Jun. 28,		Jun. 29,
		2014		2013
Foreign currency exchange contracts	Other income (expense), net	$	1	$	—
Interest rate contracts	Interest expense		5		—

Total		$	6	$	—

(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)
	Jun. 28, 2014			Jun. 29, 2013				Jun. 28, 2014			Jun. 29, 2013				Jun. 28, 2014			Jun. 29, 2013
Foreign currency exchange contracts	$	(8	)	$	3		COGS	$	1		$	3		Other income (expense), net	$	(2	)	$	—
Foreign currency exchange contracts		1			—		SGA expense		2			—		Other income (expense), net		—			—
Interest rate contracts		(16	)		—		Interest expense		—			1		N/A		—			—
Commodity contracts		—			(2	)	COGS		(2	)		(2	)	Other income (expense), net		—			—

Total	$	(23	)	$	1			$	1		$	2			$	(2	)	$	—

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

Derivatives in net investment hedging relationships


(millions)	Gain (loss) recognized in AOCI
	Jun. 28,		Jun. 29,
	2014		2013
Foreign currency exchange contracts	$	3	$	—

Total	$	3	$	—

Derivatives not designated as hedging instruments


(millions)	Location of gain (loss) recognized in income	Gain (loss) recognized in income
		Jun. 28,			Jun. 29,
		2014			2013
Foreign currency exchange contracts	Other income (expense), net	$	(1	)	$	—
Foreign currency exchange contracts	COGS		—			1
Commodity contracts	COGS		(18	)		(8	)

Total		$	(19	)	$	(7	)

The effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the year-to-date periods ended June 28, 2014 and June 29, 2013 were as follows:

Derivatives in fair value hedging relationships


(millions)	Location of gain (loss) recognized in income	Gain (loss) recognized in income(a)
		Jun. 28,		Jun. 29,
		2014		2013
Foreign currency exchange contracts	Other income (expense), net	$	2	$	3
Interest rate contracts	Interest expense		9		1

Total		$	11	$	4

(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)
	Jun. 28,			Jun. 29,				Jun. 28,			Jun. 29,				Jun. 28,			Jun. 29,
	2014			2013				2014			2013				2014			2013
Foreign currency exchange contracts	$	(3	)	$	12		COGS	$	2		$	5		Other income (expense), net	$	(2	)	$	—
Foreign currency exchange contracts		1			1		SGA expense		3			—		Other income (expense), net		—			—
Interest rate contracts		(23	)		—		Interest expense		9			2		N/A		—			—
Commodity contracts		1			(1	)	COGS		(3	)		(5	)	Other income (expense), net		—			—

Total	$	(24	)	$	12			$	11		$	2			$	(2	)	$	—

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

Derivatives not designated as hedging instruments


(millions)	Location of gain (loss) recognized in income	Gain (loss) recognized in income
		Jun. 28,			Jun. 29,
		2014			2013
Foreign currency exchange contracts	COGS	$	—		$	1
Foreign currency exchange contracts	Other income (expense), net		(2	)		—
Interest rate contracts	Interest expense		(4	)		—
Commodity contracts	COGS		(5	)		(24	)

Total		$	(11	)	$	(23	)

During the next 12 months, the Company expects $17 million of net deferred losses reported in AOCI at June 28, 2014 to be reclassified to income, assuming market rates remain constant through contract maturities.

Certain of the Company’s derivative instruments contain provisions requiring the Company to post collateral on those derivative instruments that are in a liability position if the Company’s credit rating is at or below BB+ (S&P), or Baa1 (Moody’s). The fair value of all derivative instruments with credit-risk-related contingent features in a liability position on June 28, 2014 was $67 million. If the credit-risk-related contingent features were triggered as of June 28, 2014, the

Company would be required to post additional collateral of $56 million. In addition, certain derivative instruments contain provisions that would be triggered in the event the Company defaults on its debt agreements. There were no collateral posting requirements as of June 28, 2014 triggered by credit-risk-related contingent features, however, there was $11 million of collateral posted in connection with reciprocal collateralization agreements as discussed under “Counterparty credit risk concentration and collateral requirements” below.

Financial instruments

The carrying values of the Company’s short-term items, including cash, cash equivalents, accounts receivable, accounts payable and notes payable approximate fair value. The fair value of the Company’s long-term debt, which are level 2 liabilities, is calculated based on broker quotes and was as follows at June 28, 2014:


(millions)	Fair Value		Carrying Value
Current maturities of long-term debt	$	607	$	607
Long-term debt		6,520		6,029

Total	$	7,127	$	6,636

Counterparty credit risk concentration and collateral requirements

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

Master netting agreements apply in situations where the Company executes multiple contracts with the same counterparty. Certain counterparties represent a concentration of credit risk to the Company. If those counterparties fail to perform according to the terms of derivative contracts, this would result in a loss to the Company. As of June 28, 2014, the Company was not in a significant net asset position with any counterparties with which a master netting agreement would apply.

For certain derivative contracts, reciprocal collateralization agreements with counterparties call for the posting of collateral in the form of cash, treasury securities or letters of credit if a fair value loss position to the Company or its counterparties exceeds a certain amount. In addition, the Company is required to maintain cash margin accounts in connection with its open positions for exchange-traded commodity derivative instruments executed with the counterparty that are subject to enforceable netting agreements. As of June 28, 2014 the Company had posted collateral of $11 million in the form of cash, which was reflected as an increase in accounts receivable, net on the Consolidated Balance Sheet. As of June 28, 2014 the Company posted $16 million in margin deposits for exchange-traded commodity derivative instruments, which was reflected as an increase in accounts receivable, net.

Management believes concentrations of credit risk with respect to accounts receivable is limited due to the generally high credit quality of the Company’s major customers, as well as the large number and geographic dispersion of smaller customers. However, the Company conducts a disproportionate amount of business with a small number of large multinational grocery retailers, with the five largest accounts encompassing approximately 28% of consolidated trade receivables at June 28, 2014.

Note 10 Contingencies

In connection with the Company’s on-going labor negotiations with the union representing the work-force at our Memphis, TN cereal production facility, the National Labor Relations Board filed a complaint alleging unfair labor practices under the National Labor Relations Act in March 2014. On July 30, 2014, a U.S. District Court judge ruled that the Memphis employees were entitled to return to work while the underlying litigation continues. This ruling is not expected to have a material effect on the production or distribution of products from the Memphis, TN facility or a material financial impact on the Company. As of June 28, 2014, the Company has not recorded a liability related to this matter due to the uncertainty of any potential outcome. The Company will continue to evaluate the likelihood of potential outcomes for this case as the litigation continues.

Note 11 Reportable segments

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

The Company currently manages its operations through eight operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. The reportable segments are discussed in greater detail below.

U.S. Morning Foods includes cereal, toaster pastries, health and wellness bars, and beverages.

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

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

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

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

The measurement of reportable segment results is based on segment operating profit which is generally consistent with the presentation of operating profit in the Consolidated Statement of Income. Intercompany transactions between operating segments were insignificant in all periods presented.


	Quarter ended						Year-to-date period ended
	June 28,			June 29,			June 28,		June 29,
(millions)	2014			2013			2014		2013
Net sales
U.S. Morning Foods	$	820		$	863		$	1,681	$	1,774
U.S. Snacks		893			917			1,796		1,818
U.S. Specialty		276			272			648		651
North America Other		361			388			742		791
Europe		772			723			1,480		1,415
Latin America		320			304			598		612
Asia Pacific		243			247			482		514

Consolidated	$	3,685		$	3,714		$	7,427	$	7,575

Operating profit
U.S. Morning Foods	$	143		$	180		$	271	$	343
U.S. Snacks		130			130			225		236
U.S. Specialty		63			62			150		140
North America Other		62			78			134		153
Europe		53			75			120		146
Latin America		47			42			95		90
Asia Pacific		2			17			16		38

Total Reportable Segments		500			584			1,011		1,146
Corporate		(33	)		(14	)		70		(73	)

Consolidated	$	467		$	570		$	1,081	$	1,073

KELLOGG COMPANY

PART I—FINANCIAL INFORMATION

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

Business overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand Kellogg Company, our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto contained in Item 1 of this report.

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

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 10 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 June 28, 2014, our reported net sales declined by 0.8% and internal net sales declined by 1.5%. We experienced internal net sales declines in U.S. Morning Foods, U.S. Snacks, and North America Other. Internal net sales grew in Europe, U.S. Specialty, Latin America and Asia Pacific. Reported operating profit declined by 18.1%, and underlying internal operating profit declined by 7.2%. The decline in internal profit was driven by softer sales primarily in U.S. Morning Foods and U.S. Snacks, inflation in cost of goods sold, and increased investment in brand-building. This was partially offset by continued discipline overhead control.

Reported diluted EPS of $.82 for the quarter was down 14.6% compared to the prior year of $.96. Comparable diluted EPS of $1.02 for the quarter was flat to prior year.

Reconciliation of certain non-GAAP Financial Measures


	Quarter ended						Year-to-date period ended

Consolidated results	June 28,			June 29,			June 28,			June 29,
	2014			2013			2014			2013

Reported operating profit	$	467		$	570		$	1,081		$	1,073
Mark-to-market (a)		(12	)		(7	)		104			(61	)
Restructuring and cost reduction activities (b)		(78	)		(7	)		(132	)		(20	)

Underlying operating profit (c)	$	557		$	584		$	1,109		$	1,154

Reported income taxes	$	122		$	150		$	287		$	274
Mark-to-market (a)		(4	)		(2	)		32			(19	)
Restructuring and cost reduction activities (b)		(20	)		(4	)		(38	)		(7	)

Underlying income taxes (c)	$	146		$	156		$	293		$	300

Reported effective income tax rate		29.0	%		29.9	%		28.9	%		29.2	%
Mark-to-market (a)		(0.2	)%		(0.1	)%		0.1	%		(0.3	)%
Restructuring and cost reduction activities (b)		0.5	%		0.1	%		0.1	%		0.2	%

Underlying effective income tax rate (c)		28.7	%		29.9	%		28.7	%		29.3	%

Reported net income attributable to Kellogg Company	$	295		$	352		$	701		$	663
Mark-to-market (a)		(8	)		(5	)		72			(42	)
Restructuring and cost reduction activities (b)		(58	)		(3	)		(94	)		(13	)

Underlying net income attributable to Kellogg Company (c)	$	361		$	360		$	723		$	718

Reported basic EPS	$	0.82		$	0.96		$	1.95		$	1.82
Mark-to-market (a)		(0.02	)		(0.02	)		0.20			(0.12	)
Pringles integration costs		(0.02	)		(0.03	)		(0.03	)		(0.07	)
Restructuring and cost reduction activities (b)		(0.16	)		(0.02	)		(0.26	)		(0.05	)

Comparable basic EPS (d)	$	1.02		$	1.03		$	2.04		$	2.06
Comparable basic EPS growth (d)		(1.0	)%		9.6	%		(1.0	)%		5.1	%

Reported diluted EPS	$	0.82		$	0.96		$	1.94		$	1.81
Mark-to-market (a)		(0.02	)		(0.01	)		0.20			(0.11	)
Pringles integration costs		(0.02	)		(0.03	)		(0.03	)		(0.07	)
Restructuring and cost reduction activities (b)		(0.16	)		(0.02	)		(0.26	)		(0.05	)

Comparable diluted EPS (d)	$	1.02		$	1.02		$	2.03		$	2.04
Comparable diluted EPS growth (d)		—	%		9.7	%		(0.5	)%		4.6	%

(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 second quarter of 2014 and 2013, there were no pension mark-to-market adjustments recognized. 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.

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