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
For more than 110 years, consumers have counted on
COVID-19 Response
In
Employee health and safety
The health and safety of our employees is our top priority. As a result, the
Company has designed and implemented a number of actions across the business.
From the outset of the pandemic, the Company restricted travel and visitors to
its facilities, prohibited external group meetings and established quarantine
procedures for any potentially exposed employees. The Company subsequently
required employees
Maintain our ability to produce and deliver essential food supply In addition to our efforts to keep our people safe, the Company has taken several actions to ensure that we maintain our ability to operate effectively during this pandemic, providing our foods to our customers and consumers. While we have experienced limited disruption in the operation of our facilities, we are taking the appropriate actions to ensure the continuity of our business. We are working proactively with our suppliers to maintain our supply of raw materials and packaging during this time of increased demand for our products. We have secured access to contracted labor forces. We have made incremental investments in our workforce, additional warehouse capacity and increased access to transportation so that our products are delivered in a timely manner to our customers. In conjunction with our management of production capacity, we have simplified our operations (as well as our customers' operations) by prioritizing our offerings to increase the supply of our most demanded products to our customers, as well as delaying innovation launches and commercial activities. At the same time, the Company reinforced food safety practices across our manufacturing network.
We have partnered with our strategic technology providers in order to maintain support for our critical business and finance systems as well as additional network bandwidth and support for the transition to a work-from-home
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Table of Contents environment. We are also working to mitigate system-related risks in this environment through heightened monitoring of cybersecurity and network capacity as well as reevaluation of contingency plans.
Community supportKellogg is a company with a heart and soul, and we are working together across our company to help our food bank partners and neighbors in need. To date,Kellogg and our charitable funds have donated almost$15 million in cash and food to global COVID-19 hunger relief efforts. As always, through our globalKellogg 's® Better Days purpose platform, we help deliver critical nourishment to people when they need it most. Local governments have identified food security as a top priority in their fight against COVID-19. With school and business closures and "shelter-at-home" mandates,Kellogg is providing support to our food bank partners on the front-lines, helping thosewho may not know where their next meal is coming from. Maintain financial flexibility At this time, the COVID-19 pandemic has not materially impacted our liquidity and we anticipate current cash and marketable security balances, operating cash flows, together with our credit facilities and other financing sources including commercial paper, credit and bond markets, will be adequate to meet our operating, investing and financing needs. We expect cash provided by operating activities reduced by capital expenditures of approximately$1.0 billion in 2020. We currently have$2.5 billion of unused revolving credit agreements, including$1.5 billion effective through 2023 and$1.0 billion effective throughJanuary 2021 , as well as continued access to the commercial paper markets. We are currently in compliance with all debt covenants and do not have material uncertainty about our ability to maintain compliance in future periods. In May, we issued$500 million of ten-year 2.10% Notes in anticipation of our$600 million December maturity. We continue to utilize available capacity within the Monetization and Accounts Payable Programs to maintain financial flexibility without negatively impacting working capital. Additionally, we utilized certain aspects of the Coronavirus Aid, Relief and Economic Security Act, to delay the employer share of certainU.S. payroll taxes until 2021 and 2022. Our utilization does not include a government loan and is not expected to result in any restrictions on the Company's decisions on executive compensation, payment of dividends, or share buy-back programs. As the impact of COVID-19 on the economy and our operations evolves, we will continue to assess our liquidity needs.
Monitoring future impacts The severity, magnitude and duration of the current COVID-19 pandemic is uncertain and rapidly changing. The Company is actively monitoring the pandemic and related governmental actions as they continue to develop and evolve. We will adjust our mitigation strategies as necessary to address any changing health, operational or financial risks that may arise. Beginning in March, the Company experienced a significant increase in demand for our retail products as consumers stocked up on food for at-home consumption in those markets. While this demand has moderated for certain products, we will continue to manage our production capacity during this period of high demand. We continue to monitor the business for adverse impacts of the pandemic, including volatility in the foreign exchange markets, reduced demand in our away from home businesses, supply-chain disruptions in certain markets, increased costs of employee safety and maintaining food supply, and lower revenues for certain emerging market countries with a higher concentration of traditional trade outlets. In the event the Company experiences adverse impacts from the above or other factors, the Company would also evaluate the need to perform interim impairment tests for the Company's goodwill, indefinite lived intangible assets, investments in unconsolidated affiliates and property, plant and equipment. There can be no assurance that volatility and/or disruption in the global capital and credit markets will not impair our ability to access these markets on terms acceptable to us, or at all. See further discussion within Future Outlook.
Segments
On
We manage our operations through four operating segments that are based
primarily on geographic location -
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Table of Contents Non-GAAP financial measures This filing includes non-GAAP financial measures that we provide to management and investors that exclude certain items that we do not consider part of on-going operations. Items excluded from our non-GAAP financial measures are discussed in the "Significant items impacting comparability" section of this filing. Our management team consistently utilizes a combination of GAAP and non-GAAP financial measures to evaluate business results, to make decisions regarding the future direction of our business, and for resource allocation decisions, including incentive compensation. As a result, we believe the presentation of both GAAP and non-GAAP financial measures provides investors with increased transparency into financial measures used by our management team and improves investors' understanding of our underlying operating performance and in their analysis of ongoing operating trends. All historic non-GAAP financial measures have been reconciled with the most directly comparable GAAP financial measures.
Non-GAAP financial measures used for evaluation of performance include
currency-neutral and organic net sales, adjusted and currency-neutral adjusted
operating profit, adjusted and currency-neutral adjusted diluted earnings per
share (EPS), currency-neutral adjusted gross profit, currency neutral adjusted
gross margin, adjusted other income (expense), net debt, and cash flow. We
determine currency-neutral results by dividing or multiplying, as appropriate,
the current-period local currency operating results by the currency exchange
rates used to translate our financial statements in the comparable prior-year
period to determine what the current period
•Currency-neutral net sales and organic net sales: We adjust the GAAP financial measure to exclude the impact of foreign currency, resulting in currency-neutral net sales. In addition, we exclude the impact of acquisitions, divestitures, and foreign currency, resulting in organic net sales. We excluded the items which we believe may obscure trends in our underlying net sales performance. By providing these non-GAAP net sales measures, management intends to provide investors with a meaningful, consistent comparison of net sales performance for the Company and each of our reportable segments for the periods presented. Management uses these non-GAAP measures to evaluate the effectiveness of initiatives behind net sales growth, pricing realization, and the impact of mix on our business results. These non-GAAP measures are also used to make decisions regarding the future direction of our business, and for resource allocation decisions.
•Adjusted: operating profit and diluted EPS: We adjust the GAAP financial measures to exclude the effect of restructuring programs, mark-to-market adjustments for pension plans (service cost, interest cost, expected return on plan assets, and other net periodic pension costs are not excluded), commodities and certain foreign currency contracts, multi-employer pension plan withdrawal liabilities, the gain on the divestiture of selected cookies, fruit snacks, pie crusts, and ice cream cone businesses, and other costs impacting comparability resulting in adjusted. We excluded the items which we believe may obscure trends in our underlying profitability. By providing these non-GAAP profitability measures, management intends to provide investors with a meaningful, consistent comparison of the Company's profitability measures for the periods presented. Management uses these non-GAAP financial measures to evaluate the effectiveness of initiatives intended to improve profitability, as well as to evaluate the impacts of inflationary pressures and decisions to invest in new initiatives within each of our segments.
•Currency-neutral adjusted: gross profit, gross margin, operating profit, and diluted EPS: We adjust the GAAP financial measures to exclude the effect of restructuring programs, mark-to-market adjustments for pension plans (service cost, interest cost, expected return on plan assets, and other net periodic pension costs are not excluded), commodities and certain foreign currency contracts, multi-employer pension plan withdrawal liabilities, the gain on the divestiture of selected cookies, fruit snacks, pie crusts, and ice cream cone businesses, other costs impacting comparability, and foreign currency, resulting in currency-neutral adjusted. We excluded the items which we believe may obscure trends in our underlying profitability. By providing these non-GAAP profitability measures, management intends to provide investors with a meaningful, consistent comparison of the Company's profitability measures for the periods presented. Management uses these non-GAAP financial measures to evaluate the effectiveness of initiatives intended to improve profitability, as well as to evaluate the impacts of inflationary pressures and decisions to invest in new initiatives within each of our segments.
•Adjusted effective income tax rate: We adjust the GAAP financial measures to exclude the effect of restructuring programs, mark-to-market adjustments for pension plans (service cost, interest cost, expected
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Table of Contents return on plan assets, and other net periodic pension costs are not excluded), commodities and certain foreign currency contracts, multi-employer pension plan withdrawal liabilities, the gain on the divestiture of selected cookies, fruit snacks, pie crusts, and ice cream cone businesses, and other costs impacting comparability. We excluded the items which we believe may obscure trends in our pre-tax income and the related tax effect of those items on our adjusted effective income tax rate. By providing this non-GAAP measure, management intends to provide investors with a meaningful, consistent comparison of the Company's effective tax rate, excluding the pre-tax income and tax effect of the items noted above, for the periods presented. Management uses this non-GAAP measure to monitor the effectiveness of initiatives in place to optimize our global tax rate.
•Net debt: Defined as the sum of long-term debt, current maturities of long-term debt and notes payable, less cash and cash equivalents and marketable securities. With respect to net debt, cash and cash equivalents and marketable securities are subtracted from the GAAP measure, total debt liabilities, because they could be used to reduce the Company's debt obligations. Company management and investors use this non-GAAP measure to evaluate changes to the Company's capital structure and credit quality assessment.
•Cash flow: Defined as net cash provided by operating activities reduced by expenditures for property additions. Cash flow does not represent the residual cash flow available for discretionary expenditures. 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 once all of the Company's business needs and obligations are met. Additionally, certain performance-based compensation includes a component of this non-GAAP measure.
These measures have not been calculated in accordance with GAAP and should not be viewed as a substitute for GAAP reporting measures.
Significant items impacting comparability
Mark-to-market accounting for pension plans, commodities and certain foreign
currency contracts
We recognize mark-to-market adjustments for pension plans, commodity contracts,
and certain foreign currency contracts as incurred. Actuarial gains/losses for
pension plans are recognized in the year they occur. Changes between contract
and market prices for commodities contracts and certain foreign currency
contracts result in gains/losses that are recognized in the quarter they occur.
We recorded a pre-tax mark-to-market loss of
Project K
In 2019, the Company completed implementation of all Project K initiatives. We
recorded pre-tax charges related to this program of
See the Restructuring Programs section for more information.
Brexit impacts
During 2019, with the uncertainty of the
Business and portfolio realignment One-time costs related to reorganizations in support of our Deploy for Growth priorities and a reshaped portfolio; investments in enhancing capabilities prioritized by our Deploy for Growth strategy; and completed and prospective divestitures and acquisitions, including the divestiture of our cookies, fruit snacks, pie crusts, and ice-cream cone
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businesses. As a result, we incurred pre-tax charges, primarily related to
reorganizations, of
Multi-employer pension plan withdrawal
During the second quarter of 2020, the Company recorded a pre-tax gain of
approximately
Divestiture
On
Foreign currency translation
We evaluate the operating results of our business on a currency-neutral basis.
We determine currency-neutral operating results by dividing or multiplying, as
appropriate, the current-period local currency operating results by the currency
exchange rates used to translate our financial statements in the comparable
prior-year period to determine what the current period
Financial results
For the quarter ended
Second quarter reported operating profit increased 27% versus the year-ago quarter due primarily to higher net sales and operating leverage, lower business and portfolio realignment charges, and lower brand building due to the phasing of spending towards the back half of the year, partially offset by unfavorable mark-to-market impacts, the absence of results from the divested businesses, incremental safety, sanitation, and labor costs related to the pandemic, and foreign currency impacts. Currency-neutral adjusted operating profit increased almost 27%, after excluding the impact of the divested businesses, mark-to-market, business and portfolio realignment, Project K, and foreign currency.
Reported diluted EPS of
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