| ITEM 7. |
MANAGEMENT’S
DISCUSSION
AND
ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Kellogg
Company and Subsidiaries
RESULTS OF
OPERATIONS
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 8 of this report.
Kellogg Company is the world’s leading producer of cereal
and a leading producer of convenience foods, including cookies,
crackers, toaster pastries, cereal bars, fruit snacks, frozen
waffles, and veggie foods. Kellogg products are manufactured and
marketed globally. We currently manage our operations in four
geographic operating segments, comprised of North America and
the three International operating segments of Europe, Latin
America, and Asia Pacific. Beginning in 2007, the Asia Pacific
segment includes South Africa, which was formerly a part of
Europe. Prior years were restated for comparison purposes.
We manage our Company for sustainable performance defined by our
long-term annual growth targets. During the periods presented
these targets were low single-digit for internal net sales, low
to mid single-digit for internal operating profit, and high
single-digit for net earnings per share.
|
Consolidated results |
||||||||||||||
| (dollars in millions) | 2007 | 2006 | 2005 | |||||||||||
|
Net sales
|
$ | 11,776 | $ | 10,907 | $ | 10,177 | ||||||||
|
Net sales growth:
|
As reported | 8.0% | 7.2% | 5.9% | ||||||||||
| Internal (a) | 5.4% | 6.8% | 6.4% | |||||||||||
|
Operating profit
|
$ | 1,868 | $ | 1,766 | $ | 1,750 | ||||||||
|
Operating profit growth:
|
As reported (b) | 5.8% | .9% | 4.1% | ||||||||||
| Internal (a) | 3.1% | 4.3% | 5.2% | |||||||||||
|
Diluted net earnings per share (EPS)
|
$ | 2.76 | $ | 2.51 | $ | 2.36 | ||||||||
|
EPS growth (b)
|
10% | 6% | 10% | |||||||||||
| (a) | Our measure of “internal growth” excludes the impact of currency and, if applicable, acquisitions, dispositions, and shipping day differences. Specifically, internal net sales and operating profit growth for 2005 exclude the impact of a 53rd shipping week in 2004. Internal operating profit growth for 2006 also excludes the impact of adopting SFAS No. 123(R) “Share-Based Payment.” Accordingly, internal operating profit growth for 2006 is a non-GAAP financial measure, which is further discussed and reconciled to GAAP-basis growth on page 13. | |
| (b) | At the beginning of 2006, we adopted SFAS No. 123(R) “Share-Based Payment,” which reduced our fiscal 2006 operating profit by $65 million ($42 million after tax or $.11 per share), due primarily to recognition of compensation expense associated with employee and director stock option grants. Correspondingly, our reported operating profit and net earnings growth for 2006 was reduced by approximately 4%. Diluted net earnings per share growth was reduced by approximately 5%. Refer to the section beginning on page 24 entitled “Stock compensation” for further information on the Company’s adoption of SFAS No. 123(R). |
In combination with an attractive dividend yield, we believe
this profitable growth has and will continue to provide a strong
total return to our shareholders. We plan to continue to achieve
this sustainability through a strategy focused on growing our
cereal business, expanding our snacks business, and pursuing
selected growth opportunities. We support our business strategy
with operating principles that emphasize profit-rich,
sustainable sales growth, as well as cash flow and return
on invested capital. We believe our steady earnings growth,
strong cash flow, and continued investment during a multi-year
period of significant commodity and energy-driven cost inflation
demonstrates the strength and flexibility of our business model.
2007
compared to 2006
The following tables provide an analysis of net sales and
operating profit performance for 2007 versus 2006:
|
Asia |
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|
North |
Latin |
Pacific |
||||||||||||||||||||||||
| (dollars in millions) | America | Europe | America | (a) | Corporate | Consolidated | ||||||||||||||||||||
|
2007 net sales
|
$ | 7,786 | $ | 2,357 | $984 | $649 | $ — | $ | 11,776 | |||||||||||||||||
|
2006 net sales
|
$ | 7,349 | $ | 2,057 | $891 | $610 | $ — | $ | 10,907 | |||||||||||||||||
|
% change — 2007 vs. 2006:
|
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|
Volume (tonnage) (b)
|
1.7% | 2.2% | 6.5% | −.9% | — | 2.1% | ||||||||||||||||||||
|
Pricing/mix
|
3.8% | 3.1% | 2.3% | .6% | — | 3.3% | ||||||||||||||||||||
|
Subtotal — internal business
|
5.5% | 5.3% | 8.8% | −.3% | — | 5.4% | ||||||||||||||||||||
|
Foreign currency impact
|
.5% | 9.3% | 1.6% | 6.7% | — | 2.6% | ||||||||||||||||||||
|
Total change
|
6.0% | 14.6% | 10.4% | 6.4% | — | 8.0% | ||||||||||||||||||||
|
Asia |
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|
North |
Latin |
Pacific |
||||||||||||||||||||||||
| (dollars in millions) | America | Europe | America | (a) | Corporate | Consolidated | ||||||||||||||||||||
|
2007 operating profit
|
$ | 1,345 | $ | 397 | $213 | $ 88 | $(175 | ) | $ | 1,868 | ||||||||||||||||
|
2006 operating profit
|
$ | 1,341 | $ | 321 | $220 | $ 90 | $(206 | ) | $ | 1,766 | ||||||||||||||||
|
% change — 2007 vs. 2006:
|
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|
Internal business
|
−.1% | 14.2% | −4.7% | −9.5% | 14.4% | 3.1% | ||||||||||||||||||||
|
Foreign currency impact
|
.5% | 9.7% | 1.5% | 7.2% | — | 2.7% | ||||||||||||||||||||
|
Total change
|
.4% | 23.9% | −3.2% | −2.3% | 14.4% | 5.8% | ||||||||||||||||||||
| (a) | Includes Australia, Asia and South Africa. | |
| (b) | We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments. |
During 2007, our consolidated net sales increased 8% on strong
results from broad-based growth across our operating segments.
Internal net sales grew over 5%, building on a 7% rate of
internal growth during 2006. Successful innovation,
brand-building (advertising and consumer promotion) investment
and in-store
12
execution continued to drive broad-based sales growth across
each of our enterprise-wide product groups. In fact, we achieved
growth in retail cereal sales within each of our operating
segments.
For 2007, our North America operating segment reported a net
sales increase of 6%. Internal net sales grew over 5%, with each
major product group contributing as follows: retail cereal +3%;
retail snacks (cookies, crackers, toaster pastries, cereal bars,
fruit snacks) +7%; frozen and specialty (food service, club
stores, vending, convenience, drug and value stores) channels
+6%. The significant growth achieved by our North America snacks
business built on internal growth of +11% in 2006. The 2007
growth in North America retail cereal sales represented the
7th consecutive year in which we’ve increased our
dollar share of category sales.
Our International operating segments collectively achieved net
sales growth of approximately 12% or 5% on an internal basis,
with leading dollar contributions from our businesses in the UK,
France, Mexico, and Venezuela. Internal sales of our Asia
Pacific operating segment (which represents approximately 5% of
our consolidated results) were approximately even with the prior
year, as solid growth in Asian markets was offset by weak
performance in our Australian business.
Consolidated operating profit for 2007 grew 6%, with internal
operating profit up 3% versus 2006. For 2007, Europe contributed
a strong 14% internal growth rate, driven by increased sales and
stronger gross margins, as well as lower up-front costs. Despite
a strong sales performance, operating profit in our North
American segment was dampened by continued commodity cost
pressures and significantly higher up-front costs associated
with cost reduction initiatives, as more fully discussed on
page 16. As previously predicted, our Latin America and
Asia Pacific operating segments suffered operating profit
declines, primarily driven by lower gross margins due to
increased commodity costs, as well as the previously mentioned
weak performance in our Australian business.
Our current-year operating profit growth was also affected by
significant cost pressures as discussed in the “Margin
performance” section beginning on page 14.
Expenditures for brand-building activities increased at a mid
single-digit rate; this rate of growth incorporates savings
reinvestment from our recent focus on media buying efficiencies
and global leverage of promotional campaigns. Within our total
brand-building, advertising expenditures grew at a double-digit
rate for 2007.
2006
compared to 2005
The following tables provide an analysis of net sales and
operating profit performance for 2006 versus 2005:
|
Asia |
||||||||||||||||||||||||||
|
North |
Latin |
Pacific |
||||||||||||||||||||||||
| (dollars in millions) | America | Europe | America | (a) | Corporate | Consolidated | ||||||||||||||||||||
|
2006 net sales
|
$7,349 | $ | 2,057 | $891 | $610 | $ — | $10,907 | |||||||||||||||||||
|
2005 net sales
|
$6,808 | $ | 1,925 | $822 | $622 | $ — | $10,177 | |||||||||||||||||||
|
% change — 2006 vs. 2005:
|
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|
Volume (tonnage) (b)
|
3.5% | 1.4% | 4.5% | −.7% | — | 3.1% | ||||||||||||||||||||
|
Pricing/mix
|
4.0% | 4.0% | 4.0% | 1.2% | — | 3.7% | ||||||||||||||||||||
|
Subtotal — internal business
|
7.5% | 5.4% | 8.5% | .5% | — | 6.8% | ||||||||||||||||||||
|
Foreign currency impact
|
.4% | 1.4% | −.2% | −2.4% | — | .4% | ||||||||||||||||||||
|
Total change
|
7.9% | 6.8% | 8.3% | −1.9% | — | 7.2% | ||||||||||||||||||||
|
Asia |
||||||||||||||||||||||||||
|
North |
Latin |
Pacific |
||||||||||||||||||||||||
| (dollars in millions) | America | Europe | America | (a) | Corporate | Consolidated | ||||||||||||||||||||
|
2006 operating profit
|
$1,341 | $321 | $220 | $ 90 | $(206 | ) | $1,766 | |||||||||||||||||||
|
2005 operating profit
|
$1,251 | $317 | $203 | $100 | $(121 | ) | $1,750 | |||||||||||||||||||
|
% change — 2006 vs. 2005:
|
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|
Internal business
|
6.5% | .5% | ||||||||||||||||||||||||