Annual Reports

  • 10-K (Feb 24, 2017)
  • 10-K (Feb 19, 2016)
  • 10-K (Feb 20, 2015)
  • 10-K (Mar 3, 2014)
  • 10-K (Jun 20, 2013)
  • 10-K (Feb 25, 2013)

 
Quarterly Reports

 
8-K

 
Other

Mondelez International, Inc. 10-K 2008
Form 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark one)

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

For the fiscal year ended December 31, 2007

OR

 

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

COMMISSION FILE NUMBER 1-16483

LOGO

 

 

Kraft Foods Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Virginia   52-2284372

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Three Lakes Drive, Northfield, Illinois   60093
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: 847-646-2000

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Class A Common Stock, no par value

  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Note: Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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. (Check one):

 

Large accelerated filer  x   Accelerated filer  ¨   Non-accelerated filer  ¨   Smaller reporting company  ¨
    (Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the shares of Class A Common Stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock on June 29, 2007, was $56 billion. At January 31, 2008, there were 1,533,315,478 shares of the registrant’s Class A Common Stock outstanding.

Documents Incorporated by Reference

Portions of the registrant’s definitive proxy statement for use in connection with its annual meeting of shareholders to be held on May 13, 2008, to be filed with the Securities and Exchange Commission (the “SEC”) in March 2008, are incorporated in Part III hereof and made a part hereof.

 

 

 


Kraft Foods Inc.

Table of Contents

 

            Page No.

Part I -

       

Item 1.

    

Business

   2

Item 1A.

    

Risk Factors

   11

Item 1B.

    

Unresolved Staff Comments

   13

Item 2.

    

Properties

   14

Item 3.

    

Legal Proceedings

   14

Item 4.

    

Submission of Matters to a Vote of Security Holders

   14

Part II -

       

Item 5.

    

Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities

   15

Item 6.

    

Selected Financial Data

   17

Item 7.

    

Management’s Discussion and Analysis of Financial Condition and
Results of Operations

   18

Item 7A.

    

Quantitative and Qualitative Disclosures about Market Risk

   43

Item 8.

    

Financial Statements and Supplementary Data

   45

Item 9.

    

Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

   82

Item 9A.

    

Controls and Procedures

   82
    

Report of Management on Internal Control over Financial Reporting

   83
    

Report of Independent Registered Public Accounting Firm

   84

Item 9B.

    

Other Information

   85

Part III -

       

Item 10.

    

Directors, Executive Officers and Corporate Governance

   85

Item 11.

    

Executive Compensation

   85

Item 12.

    

Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters

   85

Item 13.

    

Certain Relationships and Related Transactions, and Director
Independence

   85

Item 14.

    

Principal Accountant Fees and Services

   86

Part IV -

       

Item 15.

    

Exhibits and Financial Statement Schedules

   86
    

Signatures

   88
    

Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule

   S-1
    

Valuation and Qualifying Accounts

   S-2

In this report, “Kraft,” “we,” “us” and “our” refers to Kraft Foods Inc. and subsidiaries, and “Common Stock” refers to Kraft’s Class A common stock.

 

1


PART I

 

Item 1. Business.

General

Kraft was incorporated in 2000 in the Commonwealth of Virginia. We manufacture and market packaged foods and beverages worldwide in more than 150 countries. We have nine brands with revenues exceeding $1 billion: Kraft cheeses, dinners and dressings; Oscar Mayer meats; Philadelphia cream cheese; Maxwell House coffee; Nabisco cookies and crackers and its Oreo brand; Jacobs coffees, Milka chocolates and LU biscuits. We have more than 50 additional brands with revenues of at least $100 million.

Prior to June 13, 2001, Kraft was a wholly-owned subsidiary of Altria Group, Inc. (“Altria”). On June 13, 2001, we completed an initial public offering of 280,000,000 shares of our Common Stock at a price of $31.00 per share.

In the first quarter of 2007, Altria spun off its remaining interest (89.0%) in Kraft on a pro rata basis to Altria stockholders in a tax-free transaction. Effective as of the close of business on March 30, 2007, all Kraft shares owned by Altria were distributed to Altria’s stockholders, and our separation from Altria was completed (the “Distribution”). Before the Distribution, Altria converted all of its Class B shares of Kraft common stock into Class A shares of Kraft common stock. The Distribution ratio was calculated by dividing the number of shares of Kraft Common Stock held by Altria by the number of Altria shares outstanding on the record date, March 16, 2007. The distribution ratio was 0.692024 shares of Kraft Common Stock for every share of Altria common stock outstanding. Following the Distribution, we only have Class A common stock outstanding.

Because Kraft is a holding company, our principal source of funds is dividends from our subsidiaries. Our principal wholly-owned subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock.

Reportable Segments

We manufacture and market packaged food products, including snacks, beverages, cheese, convenient meals and various packaged grocery products. We manage and report operating results through two commercial units, Kraft North America and Kraft International. Kraft North America operates in the U.S. and Canada, and we manage Kraft North America’s operations by product category. We manage Kraft International’s operations by geographic location. We have operations in more than 70 countries and sell our products in more than 150 countries.

Note 16 to our consolidated financial statements includes a breakout of net revenues and segment operating income by reportable segment for each of the last three years. Management uses segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes unallocated general corporate expenses and amortization of intangibles. Management believes it is appropriate to disclose this measure to help investors analyze segment performance and trends.

The relative percentages of segment operating income attributable to each reportable segment were:

 

       For the Years Ended December 31,       
         2007          2006        2005       

Kraft North America:

                   

North America Beverages

     7.4%      4.3%      9.3%     

North America Cheese &
Foodservice

     13.6%      18.8%      18.6%     

North America Convenient Meals

     15.3%      19.4%      16.0%     

North America Grocery

     18.0%      19.5%      14.6%     

North America Snacks & Cereals

     22.4%      17.6%      18.8%     

Kraft International:

                   

European Union

     12.5%      11.6%      14.6%     

Developing Markets (1)

     10.8%      8.8%      8.1%     
                         

Total Kraft

     100.0%      100.0%      100.0%     
                         

 

  (1) This segment was formerly known as Developing Markets, Oceania & North Asia

 

2


Our brands span five consumer sectors:

 

   

Snacks - primarily cookies, crackers, salted snacks and chocolate confectionery;

   

Beverages - primarily coffee, aseptic juice drinks and powdered beverages;

   

Cheese - primarily natural, process and cream cheeses;

   

Grocery - primarily ready-to-eat cereals, enhancers and desserts; and

   

Convenient Meals - primarily frozen pizza, packaged dinners, lunch combinations and processed meats.

The following table shows each reportable segment’s participation in these five core consumer sectors.

 

     Percentage of 2007 Net Revenues by Consumer Sector (2)  

Segment (1)

   Snacks     Beverages     Cheese     Grocery     Convenient
Meals
    Total  

Kraft North America:

            

North America Beverages

   -     40.1 %   -     -     -     8.7 %

North America Cheese &
Foodservice

   3.1 %   3.3 %   74.0 %   7.9 %   4.1 %   17.1 %

North America Convenient Meals

   -     -     -     -     88.4 %   13.7 %

North America Grocery

   1.1 %   -     -     50.2 %   -     7.2 %

North America Snacks & Cereals

   46.0 %   -     1.1 %   23.8 %   0.1 %   17.5 %
                                    

Total Kraft North America

   50.2 %   43.4 %   75.1 %   81.9 %   92.6 %   64.2 %

Kraft International:

            

European Union

   28.2 %   37.6 %   14.7 %   7.2 %   5.8 %   21.4 %

Developing Markets

   21.6 %   19.0 %   10.2 %   10.9 %   1.6 %   14.4 %
                                    

Total Kraft International

   49.8 %   56.6 %   24.9 %   18.1 %   7.4 %   35.8 %
                                    

Total Kraft

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
                                    

Consumer Sector Percentage of Total Kraft

   30.5 %   21.6 %   18.6 %   13.8 %   15.5 %   100.0 %
                                    

 

  (1) Note 16 to our consolidated financial statements includes a breakout of net revenues, total assets and long-lived assets by geographic region, as well as a breakout of net revenues and segment operating income by reportable segment for each of the last three years.
  (2) Percentages are calculated based upon dollars rounded to millions.

Our U.S. subsidiaries export coffee products, refreshment beverages products, grocery products, cheese, biscuits, and processed meats. In 2007, these exports from the U.S. amounted to $153 million.

Products or similar products contributing 10% or more of Kraft’s consolidated net revenues for each of the three years in the period ended December 31, 2007, were:

 

        2007           2006           2005                   

Cheese

   19 %   19 %   19 %            

Biscuits

   15 %   15 %   14 %        

Coffee

   14 %   14 %   14 %        

Confectionery

   11 %   10 %   10 %        

Our major brands within each reportable segment and consumer sector are:

 

Kraft North America:

North America Beverages

  

Beverages:

   Maxwell House, General Foods International, Starbucks (under license), Yuban, Sanka, Nabob, Gevalia, and Seattle’s Best (under license) coffees; Tassimo hot beverage system; Capri Sun (under license), Kool-Aid, and Crystal Light aseptic juice drinks; Kool-Aid, Tang, Crystal Light, and Country Time powdered beverages; and Tazo teas (under license).

North America Cheese &
Foodservice
(1)

  

Cheese:

   Kraft and Cracker Barrel natural cheeses; Philadelphia cream cheese; Kraft, Velveeta, and Cheez Whiz process cheeses; Kraft grated cheeses; Polly-O cheese; Deli Deluxe process cheese slices; and Breakstone’s and Knudsen cottage cheese and sour cream.

 

3


North America Convenient
Meals

  

Convenient Meals:

   DiGiorno, Tombstone, Jack’s, Delissio, and California Pizza Kitchen (under license) frozen pizzas; Lunchables lunch combinations; Oscar Mayer and Louis Rich cold cuts, hot dogs, and bacon; Boca soy-based meat alternatives; Kraft macaroni & cheese dinners; South Beach Living (under license) pizzas and meals; Taco Bell Home Originals (under license) meal kits; Stove Top stuffing mix; and Deli Creations complete sandwiches.

Grocery:

   Back to Nature crackers, cookies, cereals, and macaroni & cheese dinners.

North America Grocery

  

Grocery:

   Jell-O dry packaged desserts; Cool Whip frozen whipped topping; Jell-O refrigerated gelatin and pudding snacks; Handi-Snacks shelf-stable pudding snacks; Kraft and Miracle Whip spoonable dressings; Kraft and Good Seasons salad dressings; A.1.steak sauce; Kraft and Bull’s-Eye barbecue sauces; Grey Poupon premium mustards; Shake N’ Bake coatings; and Kraft peanut butter.

North America Snacks &
Cereals

  

Snacks:

   Oreo, Chips Ahoy!, Newtons, Nilla, Nutter Butter, SnackWell’s, and Peek Freans cookies; Ritz, Premium, Triscuit, Wheat Thins, Cheese Nips, Honey Maid Grahams, and Teddy Grahams crackers; South Beach Living (under license) crackers, cookies, and snack bars; Planters nuts and salted snacks; Handi-Snacks two-compartment snacks; Terry’s and Toblerone chocolate confectionery products; Back to Nature bars; and Balance nutrition and energy snacks.

Cheese:

   Easy Cheese aerosol cheese spread.

Grocery:

   Post ready-to-eat cereals.

Kraft International:

  

European Union

  

Snacks:

   Milka, Suchard, Côte d’Or, Marabou, Toblerone, Freia, Terry’s, Daim / Dime, Figaro, Karuna, Lacta, Pavlides, Twist, Merenda, Meurisse, Prince Polo / Siesta, Mirabell, Pyros Mogyoros, Alpen Gold, Sport / Smash / Jazz, 3-Bit, and Belvita chocolate confectionery products; Estrella and Maarud salted snacks; and Oreo, Dorada, Digestive, Chiquilin, Tuc, Mini-Star, Mikado, Ourson, Petit Déjeuner, Cracotte, Belin, Heudebert, Grany, Petit Écolier, Pepito, Saiwa, Oro, Fonzies, Prince, Vitalinea, Opavia, and Gyori biscuits.

Beverages:

   Jacobs, Gevalia, Carte Noire, Jacques Vabre, Kaffee HAG, Grand’ Mère, Kenco, Saimaza, Meisterroestung, Maxwell House, Onko, Splendid, and Karat coffees; Tassimo hot beverage system; Tang powdered beverages; and Suchard Express, O’Boy, and Kaba chocolate drinks.

Cheese:

   Kraft, Dairylea, Sottilette, Osella, Mama Luise, and El Caserío cheeses; and Philadelphia cream cheese.

Grocery:

   Kraft pourable and spoonable salad dressings; Miracel Whip spoonable dressings; and Mirácoli sauces.

Convenient Meals:

   Lunchables lunch combinations; Kraft and Mirácoli pasta dinners and sauces; and Simmenthal canned meats.

Developing Markets

  

Snacks:

   Oreo, Chips Ahoy!, Ritz, Club Social, Express, Kraker / Honey / Aveny Bran, Marbu, Dorada, Pepitos, Variedad, Pacific, Belvita, Cerealitas, Lucky, Trakinas, Tuc, Mini-Star, Mikado, Ourson, Petit Déjeuner, Cracotte, Bolshevik, Prichuda, Jubilee, Start, Major, Merendina, Jacob’s. Chipsmore, Twisties, Biskuat, Milk Biscuit, Hi Calcium Soda and Tuc & Tiki biscuits; Milka, Toblerone, Lacta, Côte d’Or, Shot, Terrabusi, Suchard, Alpen Gold, Karuna, Korona, Poiana, Svoge, Ukraina, Vozdushny, Chudny Vecher, Terry’s, and Gallito chocolate confectionery products; and Estrella, Maarud, Kar, Lux, and Planters nuts and salted snacks.

Beverages:

   Maxwell House, Maxim, Nova Brasilia, and Jacobs coffee; Tang, Clight, Kool-Aid, Verao, Frisco, Q-Refresh-Ko, Royal, and Fresh powdered beverages; Maguary juice concentrate and ready-to-drink beverages; and Capri Sun (under license) aseptic juice drinks.

 

4


Cheese:

   Kraft, Velveeta, and Eden process cheeses; Kraft and Philadelphia cream cheese; Kraft natural cheese; and Cheez Whiz process cheese spread.

Grocery:

   Royal dry packaged desserts; Post ready-to-eat cereals; Kraft spoonable and pourable salad dressings; Miracle Whip spoonable dressings; Jell-O dessert toppings; Kraft peanut butter; and Vegemite yeast spread.

Convenient Meals:

   Kraft macaroni & cheese dinners.

 

  (1) Note that foodservice products span all Kraft North America segments and sectors.

In February 2008, we announced the implementation of our new operating structure. Our new structure reflects our strategy to Rewire the Organization for Growth. Within our new structure, business units now have full P&L accountability and are staffed accordingly. This also ensures that we are putting our resources closer to where decisions are made that affect our consumers. Our corporate and shared service functions are streamlining their organizations and focusing them on core activities that can more efficiently support the goals of the business units. Our new operating structure will result in changes to the reportable business segments within our North America commercial unit, beginning in the first quarter of 2008. These changes are:

 

   

Cheese has been organized as a standalone operating segment in order to create a more self-contained and integrated business unit in support of faster growth.

   

We are also moving our macaroni & cheese category as well as other dinner products from our Convenient Meals segment to our Grocery segment to take advantage of operating synergies.

   

Canada and North America Foodservice will be structured as a standalone reportable segment. This change will allow us to deliver on the unique requirements of the Canadian consumer and customer while maintaining strong North American linkages to innovation, new product development and new capabilities to drive our business. Furthermore, it will allow us to manage strategic customer decisions and continue to capture cross-border sales and marketing synergies within our Foodservice operations.

As a result of implementing our new operating structure, we will report the results of operations under this new structure beginning in the first quarter of 2008 and we will restate results from prior periods in a consistent manner.

Significant Acquisitions and Divestitures

Danone Biscuit:

On November 30, 2007, we acquired the global biscuit business of Groupe Danone S.A. (“Danone Biscuit”) for €5.1 billion (approximately $7.6 billion) in cash subject to purchase price adjustments. On October 12, 2007, we entered into a 364-day bridge facility agreement, and at closing, we borrowed €5.1 billion under that facility in order to finance the acquisition. The acquisition included 32 manufacturing facilities and approximately 14,000 employees. Danone Biscuit generated global revenues of approximately $2.8 billion during 2007. Danone Biscuit will report results from operations on a one month lag; as such, there was no impact on our operating results in 2007. On a proforma basis, Danone Biscuit’s net earnings for the year ended December 31, 2007 would have been insignificant to Kraft.

Post Distribution:

On November 15, 2007, we announced a definitive agreement to merge our Post cereals business (“Post Business”) into Ralcorp Holdings, Inc. (“Ralcorp”) after a tax-free distribution to our shareholders (the “Post Distribution”). We have signed an agreement with Ralcorp to execute the Post Distribution by means of a “Reverse-Morris Trust” transaction. This transaction is subject to customary closing conditions, including anti-trust approval, IRS tax-free ruling and Ralcorp shareholder approvals. To date, the anti-trust approval has been obtained. We anticipate that this transaction will be completed in mid-2008.

The Post Business had net revenues of approximately $1.1 billion in 2007 and includes such cereals as Honey Bunches of Oats, Pebbles, Shredded Wheat, Selects, Grape Nuts and Honeycomb. The brands in this transaction are distributed primarily in North America. In addition to the Post brands, the transaction includes four manufacturing facilities and certain manufacturing equipment. We anticipate that approximately 1,250 employees will join Ralcorp following the consummation of the transaction.

Our shareholders will receive at least 30.3 million shares of Ralcorp stock after the Post Distribution and the subsequent merger of the Post Business with Ralcorp. Based on market conditions prior to closing, we will determine whether the shares will be distributed in a spin-off or a split-off transaction. Either type of transaction is expected to be tax-free to our U.S. shareholders. In a spin-off transaction, our shareholders would receive a pro rata number of Ralcorp shares. In a split-off transaction, our shareholders would have the option to exchange their Kraft shares and receive Ralcorp shares at closing, resulting in a reduction

 

5


in the number of shares of our Common Stock outstanding. In addition, Kraft will receive approximately $960 million of cash-equivalent value, which will be used to repay debt.

Customers

Our five largest customers accounted for approximately 28% of our net revenues in 2007, 29% in 2006 and 26% in 2005. Our ten largest customers accounted for approximately 37% of our net revenues in 2007, 40% in 2006 and 37% in 2005. One of our customers, Wal-Mart Stores, Inc., accounted for approximately 15% of our net revenues in 2007, 15% in 2006 and 14% in 2005.

Seasonality

Demand for some of our products may be influenced by holidays, changes in seasons or other annual events. However, sales of our products are generally evenly balanced throughout the year due to the offsetting nature of demands for our diversified product portfolio.

Competition

We face competition in all aspects of our business. Competitors include large national and international companies and numerous local and regional companies. Some competitors may have different profit objectives and some international competitors may be more or less susceptible to currency exchange rates. We also compete with generic products and retailer brands, wholesalers and cooperatives. We compete primarily on the basis of product quality, brand recognition, brand loyalty, service, marketing, advertising and price. Moreover, improving our market position or introducing a new product requires substantial advertising and promotional expenditures.

Distribution

Kraft North America’s products are generally sold to supermarket chains, wholesalers, supercenters, club stores, mass merchandisers, distributors, convenience stores, gasoline stations, drug stores, value stores and other retail food outlets. In general, the retail trade for food products is consolidating. Food products are distributed through distribution centers, satellite warehouses, company-operated and public cold-storage facilities, depots and other facilities. We currently distribute most products in North America through warehouse delivery, but we deliver biscuits and frozen pizza through two direct-store delivery systems. We are in the process of combining the executional benefits of direct-store delivery with the economics of warehouse delivery and plan to complete the full rollout of a wall-to-wall delivery system by mid-2008, where one sales representative covers an entire store. We support our selling efforts through three principal sets of activities: consumer advertising in broadcast, print, outdoor and on-line media; consumer incentives such as coupons and contests; and trade promotions to support price features, displays and other merchandising of our products by our customers. Subsidiaries and affiliates of Kraft International sell their food products primarily in the same manner and also engage the services of independent sales offices and agents.

Raw Materials

We are major purchasers of dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and sugar and other sweeteners. We also use significant quantities of glass, plastic and cardboard to package our products, and natural gas for our factories and warehouses. We continuously monitor worldwide supply and cost trends of these commodities so we can act quickly to obtain ingredients and packaging needed for production. We purchase a substantial portion of our dairy raw material requirements, including milk and cheese, from independent third parties such as agricultural cooperatives and independent processors. The prices for milk and other dairy product purchases are substantially influenced by market supply and demand, as well as by government programs. Dairy commodity costs on average were $750 million higher in 2007 than in 2006.

The most significant cost item in coffee products is green coffee beans, which are purchased on world markets. Green coffee bean prices are affected by the quality and availability of supply, trade agreements among producing and consuming nations, the unilateral policies of the producing nations, changes in the value of the U.S. dollar in relation to certain other currencies and consumer demand for coffee products. In 2007, coffee bean costs on average were higher than in 2006. A significant cost item in chocolate confectionery products is cocoa, which is purchased on world markets, and the price of which is affected by the quality and availability of supply and changes in the value of the British pound sterling and the U.S. dollar relative to certain other currencies. In 2007, cocoa bean and cocoa butter costs on average were higher than in 2006. Significant cost items in our

 

6


biscuit, cereal, and grocery products are grains or wheat, corn, and soybean oil. Grain costs have experienced significant cost increases as a result of burgeoning global demand for food, livestock feed and biofuels such as ethanol and biodiesel. In 2007, grain costs on average were higher than in 2006.

During 2007, our aggregate commodity costs rose significantly as a result of higher dairy, coffee, cocoa, wheat, meat products, soybean oil and packaging costs, partially offset by lower nut costs. For 2007, our commodity costs were approximately $1,250 million higher than 2006, following an increase of approximately $275 million for 2006 compared with 2005. We expect the higher cost environment to continue, particularly for dairy, grains, energy and packaging.

The prices paid for raw materials and agricultural materials used in our products generally reflect external factors such as weather conditions, commodity market fluctuations, currency fluctuations and the effects of governmental agricultural programs. Although the prices of the principal raw materials can be expected to fluctuate as a result of these factors, we believe there will be an adequate supply of the raw materials we use and that they are generally available from numerous sources. We use hedging techniques to limit the impact of price fluctuations in our principal raw materials. However, we do not fully hedge against changes in commodity prices and these strategies may not protect us from increases in specific raw material costs.

Intellectual Property

We consider our trademarks, in the aggregate, to be material to our business. We protect our trademarks by registration or otherwise in the U.S. and in other markets where we sell our products. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. From time to time, we grant third parties licenses to use one or more of our trademarks in particular locations. Similarly, we sell some of our products under brands we license and those licenses are generally renewable at our discretion. These licensed brands include, among others:

 

   

Starbucks bagged coffee, Seattle’s Best coffee, and Torrefazione Italia coffee for sale in U.S. grocery stores and other distribution channels;

   

Starbucks and Seattle’s Best coffee T-Discs and Tazo teas T-Discs for use in our Tassimo hot beverage system;

   

Tazo teas for sale in grocery stores in the U.S.;

   

Capri Sun aseptic juice drinks for sale in the U.S., Canada and within our Developing Markets segment;

   

Taco Bell Home Originals Mexican style food products for sale in U.S. grocery stores;

   

California Pizza Kitchen frozen pizzas for sale in grocery stores in the U.S. and Canada;

   

Pebbles ready-to-eat cereals for sale in the U.S. and Canada; and

   

South Beach Living pizzas, meals, breakfast wraps, lunch wrap kits, crackers, cookies, snack bars, cereals and dressings for sale in grocery stores in the U.S.

Additionally, we own numerous patents worldwide. While our patent portfolio is material to our business, the loss of one patent or a group of related patents would not have a material adverse effect on our business. We have either been issued patents or have patent applications pending that relate to a number of current and potential products, including products licensed to others. Patents, issued or applied for, cover inventions ranging from basic packaging techniques to processes relating to specific products and to the products themselves. Our issued patents extend for varying periods according to the date of patent application filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage as determined by the patent office or courts in the country, and the availability of legal remedies in the country. We consider that in the aggregate our patent applications, patents and licenses under patents owned by third parties are of material importance to our operations. We are currently involved in a number of legal proceedings relating to the scope of protection and validity of our patents and those of others. These proceedings may result in a significant commitment of our resources in the future and, depending on their outcome, may adversely affect the validity and scope of certain of our patent or other proprietary rights.

We also have proprietary trade secrets, technology, know-how processes and related intellectual property rights that are not registered.

Research and Development

We pursue four objectives in research and development: product safety and quality; growth through new products; superior consumer satisfaction; and reduced costs. We have more than 2,100 food scientists, chemists and engineers working primarily in

 

7


six key technology centers: East Hanover, New Jersey; Glenview, Illinois; Tarrytown, New York; Banbury, United Kingdom; Paris, France; and Munich, Germany. These technology centers are equipped with pilot plants and state-of-the-art instruments. Research and development expense was $447 million in 2007, $419 million in 2006 and $385 million in 2005.

Regulation

Our U.S. food products and packaging materials are regulated by the Food and Drug Administration or, for products containing meat and poultry, the Food Safety and Inspection Service of the U.S. Department of Agriculture. These agencies enact and enforce regulations relating to the manufacturing, distribution and labeling of food products.

In addition, various states regulate our U.S. operations by licensing plants, enforcing federal and state standards for selected food products, grading food products, inspecting plants and warehouses, regulating trade practices related to the sale of dairy products and imposing their own labeling requirements on food products.

Many of the food commodities we use in our U.S. operations are subject to governmental agricultural programs. These programs have substantial effects on prices and supplies and are subject to Congressional and administrative review.

All of our non-U.S.-based operations are subject to local and national regulations some of which are similar to those applicable to our U.S. operations. For example, in the EU, requirements apply to labeling, packaging, food content, pricing, marketing and advertising and related areas.

Environmental Regulation

We are subject to various federal, state, local and foreign laws and regulations relating to the protection of the environment. We accrue for environmental remediation obligations on an undiscounted basis when amounts are probable and can be reasonably estimated. The accruals are adjusted as new information develops or circumstances change. Recoveries of environmental remediation costs from third parties are recorded as assets when their receipt is deemed probable. In the U.S., the laws and regulations include the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act and Superfund, which imposes joint and severable liability on each responsible party. As of December 31, 2007, our subsidiaries were involved in 70 active Superfund and other similar actions in the U.S. related to current operations and certain former or divested operations for which we retain liability.

Outside the U.S., we are subject to applicable multi-national, national and local environmental laws and regulations in the host countries in which we do business. We have specific programs across our international business units designed to meet applicable environmental compliance requirements.

Based on information currently available, we believe that the ultimate resolution of existing environmental remediation actions and our compliance in general with environmental laws and regulations will not have a material effect on our financial results. However, we cannot quantify with certainty the potential impact of future compliance efforts and environmental remediation actions.

Employees

At December 31, 2007, we employed approximately 103,000 people worldwide. Labor unions represent approximately 30% of our 41,000 employees in the U.S. Most of the unionized workers at our domestic locations are represented under contracts with the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union; the United Food and Commercial Workers International Union; and the International Brotherhood of Teamsters. These contracts expire at various times throughout the next several years. Outside the U.S., labor unions or workers’ councils represent approximately 55% of our 62,000 employees. Our business units are subject to various laws and regulations relating to their relationships with their employees. These laws and regulations are specific to the location of each enterprise. In addition, in accordance with EU requirements, we have established European Works Councils composed of management and elected members of our workforce. We believe that our relationships with employees and their representative organizations are good.

In January 2004, we announced a three-year restructuring program (the “Restructuring Program”) and, in January 2006, extended it through 2008. In connection with our severance initiatives, we have eliminated approximately 11,000 positions as of December 31, 2007; at that time we had announced the elimination of an additional 400 positions. Upon completion of the Restructuring Program, we expect to have eliminated approximately 13,500 positions.

 

8


Executive Officers of the Registrant

The following are our executive officers as of February 25, 2008:

 

Name

   Age   

Title

Irene B. Rosenfeld

   54   

Chairman and Chief Executive Officer

David Brearton

   47   

Executive Vice President, Operations and Business Services

Marc S. Firestone

   48   

Executive Vice President, Corporate and Legal Affairs and General Counsel

Sanjay Khosla

   56   

Executive Vice President and President, Kraft International

Karen J. May

   49   

Executive Vice President, Global Human Resources

Timothy R. McLevish

   52   

Executive Vice President and Chief Financial Officer

Richard G. Searer

   54   

Executive Vice President and President, Kraft North America

Jean E. Spence

   50   

Executive Vice President, Global Technology and Quality

Mary Beth West

   45   

Executive Vice President and Chief Marketing Officer

Ms. Rosenfeld was appointed as Chief Executive Officer of Kraft in June 2006 and assumed the additional role of Chairman in March 2007. Prior to that, she had been Chairman and Chief Executive Officer of Frito-Lay, a division of PepsiCo. Ms. Rosenfeld had been employed continuously by Kraft in various capacities from 1981 until 2003. Ms. Rosenfeld is also a member of the Cornell University Board of Trustees.

Mr. Brearton was appointed to his current position effective January 1, 2008. Prior to that, he served as Executive Vice President, Global Business Services and Strategy, as Senior Vice President of Business Process Simplification and as Corporate Controller for Kraft Foods Inc. He previously served as a Senior Vice President, Finance for Kraft. Mr. Brearton first joined Kraft in 1984. Mr. Brearton is also on the Board of Directors for America’s Second Harvest.

Mr. Firestone was appointed as Executive Vice President, Corporate and Legal Affairs and General Counsel in January 2006. He previously served as Kraft’s Executive Vice President, General Counsel and Corporate Secretary. Prior to joining Kraft in 2003, Mr. Firestone served as Senior Vice President and General Counsel of Philip Morris International.

Mr. Khosla was appointed as Executive Vice President and President, Kraft International in January 2007. Before joining Kraft, he served as the Managing Director of the consumer and foodservice business for the New Zealand-based Fonterra Co-operative Group. Previously Mr. Khosla spent 27 years with Unilever in India, London and Europe.

Ms. May was appointed as Executive Vice President, Global Human Resources in October 2005. Prior to joining Kraft, she had been Corporate Vice President, Human Resources for Baxter International Inc. Ms. May serves on the Board of Directors of MB Financial Inc.

Mr. McLevish was appointed as Executive Vice President and Chief Financial Officer in October 2007. Prior to that, he had been the Senior Vice President and Chief Financial Officer at Ingersoll-Rand Company Limited. Mr. McLevish serves on the Board of Directors of Kennametal Inc.

Mr. Searer was appointed as Executive Vice President and President, Kraft North America in September 2006. Previously, Mr. Searer served as the Group Vice President and President, North America Convenient Meals Sector. Mr. Searer joined Kraft in 1981.

Ms. Spence was appointed as Executive Vice President, Global Technology and Quality in January 2004. Prior to her current position, Ms. Spence served as the Senior Vice President, Research and Development, Kraft Foods North America. She joined Kraft in 1981.

Ms. West was appointed as Executive Vice President and Chief Marketing Officer in October 2007. Previously, she served as a Group Vice President for Kraft and President of the North America Beverages Sector. Ms. West joined Kraft in 1986. Ms. West currently serves on Board of Directors for J.C. Penney Co., Inc. and is a member of the Executive Leadership Council.

James P. Dollive, 56, was appointed Executive Vice President and Chief Financial Officer in 2006. In 2001, he was named as Senior Vice President and Chief Financial Officer and prior to that he held various positions with increasing responsibility within Kraft. Mr. Dollive joined Kraft in 1978 and will retire from Kraft effective February 29, 2008.

 

9


Franz - Josef H. Vogelsang, 57, was appointed as Executive Vice President, Global Supply Chain in January 2004. Prior to that role, he served as Senior Vice President, Operations, Procurement and Supply Chain for Kraft Foods International since 1998. Mr. Vogelsang retired from Kraft on January 1, 2008.

We adopted The Kraft Foods Code of Conduct for Compliance and Integrity, which qualifies as a code of ethics under Item 406 of Regulation S-K. The code applies to all of our employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. Our code of ethics is available free of charge on our website at http://www.kraft.com/assets/pdf/KraftFoods_CodeofConduct.pdf and will be provided free of charge to any stockholder submitting a written request to: Corporate Secretary, Kraft Foods Inc., Three Lakes Drive, Northfield, IL 60093. We will disclose any waiver we grant to our principal executive officer, principal financial officer, principal accounting officer or controller under our code of ethics, or certain amendments to the code of ethics, on our website at www.kraft.com.

In addition, we adopted Corporate Governance Guidelines, charters for each of the Board’s four standing committees and the Code of Business Conduct and Ethics for Directors. All of these materials are available on our website at www.kraft.com and will be provided free of charge to any stockholder requesting a copy by writing to: Corporate Secretary, Kraft Foods Inc., Three Lakes Drive, Northfield, IL 60093. Certain of these materials may also be found in the proxy statement relating to our 2008 Annual Meeting of Shareholders.

Available Information

Our Internet address is www.kraft.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge as soon as possible after we electronically file them with, or furnish them to, the SEC. You can access our filings with the SEC by visiting http://www.kraft.com/Investor/sec-filings-annual-report/. The information on our website is not, and shall not be deemed to be, a part of this Annual Report on Form 10-K or incorporated into any other filings we make with the SEC.

You can also read and copy any document that we file, including this Annual Report on Form 10-K, at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Call the SEC at 1-800-SEC-0330 for information on the operation of the Public Reference Room. In addition, the SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. You can electronically access our SEC filings there.

Forward-Looking Statements

This report contains forward-looking statements regarding our expectation that there will be an adequate supply of the raw materials we use and that they are generally available from numerous sources; that our relationships with our employees and their representative organizations are good; with regard to our intent to merge our Post cereals business with Ralcorp, the closing date and that closing is subject to customary closing conditions, the number of employees we anticipate will join Ralcorp, the amount of Ralcorp stock our shareholders will own, that the transaction is expected to be tax-free to our U.S. shareholders, the effects depending on whether we determine to do a spin-off or a split-off and the amount of cash we will receive; with regard to the Danone global biscuit business that we plan to build profitable scale by expanding distribution reach in countries with rapidly growing demand; our plan to contain administrative overhead while investing in quality, R&D, marketing , sales and other capabilities that support growth; the amount we will spend on quality upgrades in 2008; with regard to our Restructuring Program, our pre-tax charges, the number of facilities we intend to close and the number of positions we will eliminate, the use of cash to pay approximately $1.7 billion of the charges and the amount of cumulative and annualized savings; with regard to implementing our new operating structure, the intent to simplify, streamline and increase accountability to generate reliable growth for Kraft and the number of positions we are eliminating; the number of positions we will eliminate in connection with severance initiatives; our belief that the ultimate resolution of existing environmental remediation actions and our compliance with environmental laws and regulations will not have a material effect on our financial results; that the assumptions we use in recording our pension and postretirement plan obligations are reasonable; our health care cost trend rate assumption; the date we intend to adopt the measurement provisions of SFAS No. 158 and that it will not have a significant impact; our anticipated decrease in 2008 pre-tax U.S. and non-U.S. pension and postretirement expense and that our assumptions will not change further; our belief regarding our liquidity; our growth strategy regarding acquisitions and divestitures; our expectation for, and how we intend to fund, 2008 capital expenditures; our intent to repay borrowings under

 

10


the Danone Biscuit facility from the proceeds of the issuance of investment grade bonds or other securities; our expectation to continue to meet financial covenants under our revolving credit facility; the amount of our expected payment for tax liabilities; our expectation to complete the current authorization under our share repurchase program before the authorization expires in March 2009; and our 2008 Outlook, specifically diluted EPS, costs, savings and spending related to our Restructuring Program; and our 2008 effective tax rate.

These forward-looking statements involve risks and uncertainties, and the cautionary statements contained in the “Risk Factors” found in this Annual Report on Form 10-K identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Such factors, include, but are not limited to, continued higher input costs, pricing actions, increased competition, our ability to differentiate our products from private label products, increased costs of sales, our ability to realize the expected cost savings and spending from our planned Restructuring Program, difficulty in obtaining materials from our suppliers, the ability to supply our products and meet demand for our products, our indebtedness and our ability to pay our indebtedness, unexpected safety or manufacturing issues, FDA or other regulatory actions or delays, unanticipated expenses such as litigation or legal settlement expenses, our inability to successfully integrate the Danone Biscuit business, our failure to consummate the Post merger, a shift in our product mix to lower margin offerings, risks from operating internationally, our ability to protect our intellectual and other proprietary rights, our ability to retain key employees and tax law changes. We disclaim and do not undertake any obligation to update or revise any forward-looking statement in this Form 10-K.

 

Item 1A. Risk Factors.

You should read the following risk factors carefully in connection with evaluating our business and the forward-looking information contained in this Annual Report on Form 10-K. Any of the following risks could materially adversely affect our business, operating results, financial condition and the actual outcome of matters as to which forward-looking statements are made in this Annual Report on Form 10-K. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, performance or financial condition in the future.

We operate in a highly competitive industry, which may affect our profitability.

The food industry is intensely competitive. We compete based on price, product innovation, product quality, brand recognition and loyalty, effectiveness of marketing, promotional activity and the ability to identify and satisfy consumer preferences. From time to time, we may need to reduce our prices in response to competitive and customer pressures and to maintain our market share. Competition and customer pressures, however, also may restrict our ability to increase prices in response to commodity and other input cost increases. Our results of operations will suffer if profit margins decrease, as a result of either a reduction in prices or increased input costs, and if we are unable to increase sales volumes to offset those profit margin decreases.

We may also need to increase spending on marketing, advertising and new product innovation to protect existing market share or capture increased market share. The success of our investments is subject to risks, including uncertainties about trade and consumer acceptance. As a result, our increased expenditures may not maintain or enhance market share and could result in lower profitability.

Our brand image may be challenged to compete against lower-priced private label items, particularly in times of economic downturns.

Retailers are increasingly offering private label products that compete with our products. Consumers’ willingness to purchase our products will depend upon our ability to offer products that appeal to consumers at the right price. It is also important that our products are perceived to be of a higher quality than less expensive alternatives. If the difference in quality between our products and those of store brands narrows, or if such difference in quality is perceived to have narrowed, then consumers may not buy our products. Furthermore, during periods of economic uncertainty, consumers tend to purchase more private label or other economy brands, which could reduce sales volumes of our higher margin products or there could be a shift in our product mix to our lower margin offerings. If we are not able to maintain or improve our brand image, it could have a material affect on our market share and our profitability.

 

11


Consolidation of retail customers may affect our operating margins and profitability. In addition, the loss of a significant customer could significantly affect our results of operations.

Retail customers, such as supermarkets, warehouse clubs and food distributors, continue to consolidate in the U.S., the EU and our other major markets. These consolidations have produced large, sophisticated customers with increased buying power. These larger retailers are capable of operating with reduced inventories, they can resist price increases, and they demand lower pricing, increased promotional programs and specifically tailored products. They also may use shelf space currently used for our products for their own private label products. If we fail to respond to these trends, our volume growth could slow or we may need to lower our prices or increase our investments in marketing, any of which could adversely affect our profitability.

Our largest customer, Wal-Mart Stores, Inc., accounted for approximately 15% of our net revenues during 2007. During 2007, our five largest customers accounted for approximately 28% of our net revenues. The loss of any one of our top customers could have a material adverse affect on our sales.

Continuing increases in commodity costs may affect our profitability.

We are a major purchaser of commodities including, dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and sugar and other sweeteners. We also use significant quantities of glass, plastic and cardboard to package our products, and natural gas for our factories and warehouses. Price volatility for commodities we purchase has increased due to conditions outside of our control, including fluctuations in commodities markets, currency fluctuations and changes in governmental agricultural programs. If we are unable to increase our prices to offset increased commodity costs or achieve cost efficiencies in manufacturing and distribution, our profitability could suffer.

Our product sales depend on our ability to predict, identify and interpret changes in consumer preferences and develop and offer new products rapidly enough to meet those changes.

Consumer preferences for food products change continually. For example, recently, consumers have been increasingly focused on health and wellness with respect to the food products they buy. As a result, over the last several years our products have been subject to scrutiny relating to genetically modified organisms and the health implications of obesity and trans-fatty acids. Our success depends on our ability to predict, identify and interpret the tastes and dietary habits of consumers and to offer products that appeal to those preferences. We have been and will continue to be affected by publicity concerning the health implications of our products, some of which could negatively influence consumer perception and acceptance of our products and marketing programs.

Furthermore, if we do not succeed in offering products that appeal to consumers, our sales and market share will decrease, and our profitability will suffer. We must be able to distinguish among short-term fads, mid-term trends and long-term changes in consumer preferences. If we are unable to accurately predict which shifts in consumer preferences will be long-term, or if we fail to introduce new and improved products to satisfy those preferences, our sales will decline. In addition, because of our varied consumer base, we must offer a sufficient array of products to satisfy the broad spectrum of consumer preferences. If we fail to successfully innovate products across a multitude of product categories or if we do not rapidly develop products in faster growing and more profitable categories, demand for our products will decrease and our profitability could suffer.

Our international operations are subject to additional risks.

Approximately 42% of our 2007 sales and approximately 39% of our 2006 sales were generated in foreign countries. Our international operations are subject to inherent risks, including fluctuations in currency values, unpredictability of foreign currency exchange controls, discriminatory fiscal policies, unexpected changes in local regulations and laws in foreign countries and the uncertainty of enforcement of remedies in foreign jurisdictions. In addition, international sales are subject to risks related to imposition of tariffs, quotas, trade barriers and other similar restrictions. Moreover, economic changes, terrorist activity, political unrest and other economic or political uncertainties may interrupt or otherwise negatively affect our business. All of these risks could result in increased costs or decreased revenues, either of which could adversely affect our profitability.

We may not be able to successfully consummate proposed acquisitions or divestitures or successfully integrate acquired businesses.

From time to time, we evaluate acquisition candidates that would strategically fit our business objectives. If we are unable to complete, successfully integrate and develop these acquisition candidates to realize revenue growth and cost savings, our

 

12


financial results could be adversely affected. In addition, from time to time, we divest businesses that do not meet our strategic objectives, or do not meet our growth or profitability targets. Our profitability may be affected by either gains or losses on the sales of, or lost operating income from those businesses. Also, we may not be able to complete desired or proposed divestitures on terms favorable to us. Moreover, we may incur asset impairment charges related to acquisitions or divestitures which may reduce our profitability. Finally, our acquisition or divestiture activities may present financial, managerial and operational risks, including diversion of management attention from existing core businesses, integrating or separating personnel and financial and other systems, adverse effects on existing business relationships with suppliers and customers, inaccurate estimates of fair value made in the accounting for acquisitions and amortization of acquired intangible assets which would reduce future reported earnings, potential loss of customers or key employees of acquired businesses, and indemnities and potential disputes with the buyers or sellers. Any of these activities could affect our product sales, financial conditions and results of operations.

Product recalls, injuries caused by products or other legal claims could affect our reputation and profitability.

Selling products for human consumption involves inherent legal risks. We could be required to recall products due to product contamination, spoilage or other adulteration, product misbranding or product tampering. We may also suffer losses if our products or operations violate applicable laws or regulations, or if our products cause injury, illness or death. In addition, our advertising could be the target of claims of false or deceptive advertising. A significant product liability or other legal judgment against us, or a widespread product recall may adversely affect our profitability. Moreover, even if a product liability or consumer fraud claim is unsuccessful, has no merit or is not pursued, the negative publicity surrounding assertions against our products or processes could adversely affect our reputation and brand image.

We operate in a highly regulated environment.

Food production and marketing are highly regulated by a variety of federal, state, local and foreign agencies. New regulations and changes to existing regulations are issued regularly. Increased governmental regulation of the food industry, such as proposed requirements designed to enhance food safety or to regulate imported ingredients, could increase our costs and adversely affect our profitability.

Changes in our credit ratings could increase our financing costs.

We maintain revolving credit facilities that historically have been used to support the issuance of commercial paper. A downgrade in our credit ratings, particularly our short-term debt rating, would likely reduce the amount of commercial paper we could issue or it could raise our borrowing costs, or both.

Volatility in the equity markets or interest rates could substantially increase our pension costs.

At the end of 2007, the projected benefit obligation of our defined benefit pension plans was $10.2 billion and assets were $11.0 billion. The difference between plan obligations and assets, or the funded status of the plans, significantly affects the net periodic benefit costs of our pension plans and the ongoing funding requirements of those plans. Among other factors, changes in interest rates, mortality rates, early retirement rates, investment returns and the market value of plan assets can (i) affect the level of plan funding; (ii) cause volatility in the net periodic pension cost; and (iii) increase our future funding requirements. In addition, if we divest certain businesses, we may be required to increase future contributions to the benefit plans and the related net periodic pension cost could increase. A significant increase in our funding requirements could have a negative impact on our results of operations and profitability.

 

Item 1B. Unresolved Staff Comments.

We have received no written comments regarding our quarterly, annual or current reports from the staff of the SEC that remain unresolved.

 

13


Item 2. Properties.

We have 187 manufacturing and processing facilities worldwide. In North America, we have 64 facilities, and outside of North America, we have 123 facilities located in 44 countries. These manufacturing and processing facilities are located throughout the following territories:

 

   

Territory

   Number of
Facilities
 

U.S.

   51
 

Canada

   13
 

European Union

   67
 

Eastern Europe, Middle East and Africa

   17
 

Latin America

   20
 

Asia Pacific

   19
      
 

Total

   187
      

We own 181 and lease six of these manufacturing and processing facilities. We maintain all of our plants and properties in good condition, and we believe they are suitable and adequate for our present needs.

We have publicly announced, but not yet completed the sale or closure of five facilities in the U.S., three facilities in Canada, six facilities in Europe, one facility in Asia Pacific and two facilities in Latin America. The numbers above include these facilities.

As of December 31, 2007, our distribution facilities consisted of 313 distribution centers and depots worldwide. In North America, we had 302 distribution centers and depots, more than 75% of which support our direct-store-delivery systems. Outside North America, we had eleven distribution centers in seven countries. We own 39 of these distribution centers and three of these depots, and we lease 128 of these distribution centers and 143 of these depots. We believe that all of these facilities are in good condition and have sufficient capacity to meet our distribution needs in the near future.

In January 2004, we announced a three-year Restructuring Program and in January 2006, extended it through 2008. As part of the Restructuring Program, we anticipate closing up to 35 facilities. We announced the closure of three plants during 2007; we have now announced the closure of 30 facilities since the program began in 2004.

 

Item 3. Legal Proceedings.

On August 27, 2007, The Proctor & Gamble Company (“P&G”) filed suit in the U.S. District Court for the Northern District of California against our wholly-owned subsidiary, Kraft Foods Global, Inc. (“KFGI”), for patent infringement. P&G alleges that the plastic packaging for our Maxwell House® brand coffee infringes their U.S. Patent Number 7,169,418, entitled “Packaging System to Provide Fresh Packed Coffee” (“P&G Patent”). P&G seeks, among other things, preliminary and permanent injunctions enjoining our use of the alleged infringing plastic packaging, and unspecified damages. The P&G Patent is, at the same time, the subject of a pending inter partes reexamination proceeding before the U.S. Patent and Trademark Office, which could either invalidate, or validate, the patent, in its entirety or in part. For this reason, KFGI filed a Motion to Stay the patent infringement suit on grounds that the outcome of the inter partes reexamination could dispose of all or some of the asserted claims. On October 11, 2007, the Court granted KFGI’s Motion to Stay. P&G filed an appeal of the stay in the Court of Appeals for the Federal Circuit on November 9, 2007, and KFGI then filed a motion to dismiss P&G’s appeal on December 17, 2007. A decision on the motion is pending at this time. No further rulings are expected in this patent infringement suit pending the outcome of the inter partes reexamination.

 

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of security holders during the fourth quarter of 2007.

 

14


PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The information called for under Part II Items 5(a) and (b) are incorporated by reference to footnote 17, Quarterly Financial Data (Unaudited), which is included within Item 8.

(c) Issuer Purchases of Equity Securities during the Quarter ended December 31, 2007.

Our share repurchase program activity for the three months ended December 31, 2007 was:

 

Period

   Total Number of
Shares Purchased
   Average Price Paid
per Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or

Programs (1)(2)
   Approximate Dollar
Value of Shares that
May Yet Be Purchased
Under the Plans or
Programs (1)

October 1-October 31, 2007

   -    $ -    90,861,632    $ 2,000,000,828

November 1-November 30, 2007

   9,140,000    $ 33.22    100,001,632    $ 1,696,403,160

December 1-December 31, 2007

   5,655,171    $ 34.73    105,656,803    $ 1,500,000,842
             

Pursuant to Publicly Announced
Plans or Programs

   14,795,171         

October 1-October 31, 2007 (3)

   10,222    $ 34.37      

November 1-November 30, 2007 (3)

   1,311    $ 33.58      

December 1-December 31, 2007 (3)

   -    $ -      
             

For the Quarter Ended
December 31, 2007

   14,806,704    $ -      
             

 

  (1) Immediately following the Distribution, we announced a new $5.0 billion, two-year share repurchase program. We are not obligated to acquire any amount of our Common Stock and may suspend the program at our discretion.
  (2) Aggregate number of shares repurchased under the share repurchase program as of the end of the period presented.
  (3) Shares tendered to us by employees who vested in restricted stock and rights, and used shares to pay the related taxes. As such, these are non-cash transactions.

The principal stock exchange on which our Common Stock is listed is the NYSE. At January 31, 2008, there were approximately 87,000 holders of record of our Common Stock.

 

15


(d) Performance Graph.

Comparison of Five-Year Cumulative Total Return

The following graph compares the cumulative total return on our Common Stock with the cumulative total return of the S&P 500 Index and the performance peer group index. The graph assumes the reinvestment of all dividends on a quarterly basis.

LOGO

 

Date

   Kraft Foods    S&P 500    Performance
Peer Group

December 2002

   $ 100.00    $ 100.00    $ 100.00

December 2003

   $ 84.57    $ 128.63    $ 115.19

December 2004

   $ 95.68    $ 142.59    $ 122.98

December 2005

   $ 77.86    $ 149.58    $ 129.36

December 2006

   $ 101.57    $ 173.15    $ 155.10

December 2007

   $ 95.75    $ 182.64    $ 185.94

The Kraft performance peer group consists of the following companies considered our market competitors, or that have been selected on the basis of industry, level of management complexity, global focus or industry leadership: Anheuser-Busch Companies, Inc., Cadbury Schweppes plc, Campbell Soup Company, The Clorox Company, The Coca-Cola Company, Colgate-Palmolive Company, ConAgra Foods, Inc., Diageo plc, General Mills, Inc., Groupe Danone, H.J. Heinz Company, Hershey Foods Corporation, Kellogg Company, Nestlé S.A., PepsiCo, Inc., The Procter & Gamble Company, Sara Lee Corporation, and Unilever N.V.

The graph and other information furnished under this Part II Item 5(a) of this Form 10-K shall not be deemed to be “soliciting material” or to be “filed” with the Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act of 1934, as amended.

 

16


Item 6. Selected Financial Data.

Kraft Foods Inc.

Selected Financial Data - Five Year Review (in millions of dollars, except per share and employee data)

 

    2007     2006     2005     2004     2003  

Summary of Operations:

         

Net revenues

  $ 37,241     $ 34,356     $ 34,113     $ 32,168     $ 30,498  

Cost of sales

    24,651       21,940       21,845       20,281       18,531  

Operating income

    4,331       4,521       4,749       4,609       5,856  

Interest and other debt expense, net

    604       510       636       666       665  
                                       

Earnings from continuing operations, before income taxes

    3,727       4,011       4,113       3,943       5,191  

Pre-tax profit margin from continuing operations

    10.0 %     11.7 %     12.1 %     12.3 %     17.0 %

Provision for income taxes

    1,137       951       1,209       1,274       1,812  

(Loss)/earnings from discontinued operations, net
of income taxes

    -       -       (272 )     (4 )     97  
                                       

Net earnings

    2,590       3,060       2,632       2,665       3,476  

Basic EPS:

         

Continuing operations

    1.64       1.86       1.72       1.56       1.95  

Discontinued operations

    -       -       (0.16 )     -       0.06  
                                       

Net earnings

    1.64       1.86       1.56       1.56       2.01  

Diluted EPS:

         

Continuing operations

    1.62       1.85       1.72       1.55       1.95  

Discontinued operations

    -       -       (0.17 )     -       0.06  
                                       

Net earnings

    1.62       1.85       1.55       1.55       2.01  

Dividends declared per share

    1.04       0.96       0.87       0.77       0.66  

Weighted average shares (millions) - Basic

    1,575       1,643       1,684       1,709       1,727  

Weighted average shares (millions) - Diluted

    1,594       1,655       1,693       1,714       1,728  

Capital expenditures

    1,241       1,169       1,171       1,006       1,085  

Depreciation

    873       884       869       868       804  

Property, plant and equipment, net

    10,778       9,693       9,817       9,985       10,155  

Inventories

    4,096       3,506       3,343       3,447       3,343  

Total assets

    67,993       55,574       57,628       59,928       59,285  

Long-term debt

    12,902       7,081       8,475       9,723       11,591  

Total debt

    21,009       10,821       11,200       12,518       13,462  

Shareholders’ equity

    27,295       28,555       29,593       29,911       28,530  

Common dividends declared as a % of Basic EPS

    63.4 %     51.6 %     55.8 %     49.4 %     32.8 %

Common dividends declared as a % of Diluted EPS

    64.2 %     51.9 %     56.1 %     49.7 %     32.8 %

Book value per common share outstanding

    17.79       17.45       17.72       17.54       16.57  

Market price per Common Stock share - high/low

    37.20-29.95       36.67-27.44       35.65-27.88       36.06-29.45       39.40-26.35  

Closing price of Common Stock at year end

    32.63       35.70       28.17       35.61       32.22  

Price/earnings ratio at year end - Basic

    20       19       18       23       16  

Price/earnings ratio at year end - Diluted

    20       19       18       23       16  

Number of common shares outstanding at year end (millions)

    1,534       1,636       1,670       1,705       1,722  

Number of employees

    103,000       90,000       94,000       98,000       106,000  

 

17


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.

The following discussions should be read in conjunction with the other sections of this report, including the consolidated financial statements and related notes contained in Item 8 of this Form 10-K.

Description of the Company

We manufacture and market packaged food products, including snacks, beverages, cheese, convenient meals and various packaged grocery products, worldwide in more than 150 countries.

Kraft Spin-Off from Altria:

In the first quarter of 2007, Altria Group, Inc. (“Altria”) spun off its remaining interest (89.0%) in Kraft on a pro rata basis to Altria stockholders in a tax-free transaction. Effective as of the close of business on March 30, 2007, all Kraft shares owned by Altria were distributed to Altria’s stockholders, and our separation from Altria was completed (the “Distribution”). Before the Distribution, Altria converted all of its Class B shares of Kraft common stock into Class A shares of Kraft common stock. The Distribution ratio was calculated by dividing the number of shares of Kraft Common Stock held by Altria by the number of Altria shares outstanding on the record date, March 16, 2007. The distribution ratio was 0.692024 shares of Kraft Common Stock for every share of Altria common stock outstanding. Following the Distribution, we only have Class A common stock outstanding.

Executive Summary

The following executive summary is intended to provide significant highlights of the Discussion and Analysis that follows.

 

   

Net revenues in 2007 increased 8.4% to $37.2 billion. Net revenues in 2006 increased 0.7% to $34.4 billion.

 

   

Diluted EPS in 2007 decreased 12.4% to $1.62. Diluted EPS in 2006 increased 19.4% to $1.85.

 

   

We recorded Restructuring Program charges of $459 million during 2007, $673 million during 2006 and $297 million during 2005.

 

   

We made solid progress executing our long-term growth strategy, which focuses on: rewiring the organization for growth; reframing our categories; exploiting our sales capabilities; and driving down costs without compromising quality.

 

   

On November 30, 2007, we acquired the global biscuit business of Groupe Danone S.A. for approximately €5.1 billion (approximately $7.6 billion) in cash subject to purchase price adjustments. We will report the results from operations on a one month lag; as such, there was no impact on our operating results in 2007.

 

   

On November 15, 2007, we announced a definitive agreement to merge our Post cereals business into Ralcorp Holdings, Inc. The transaction is subject to customary closing conditions, including anti-trust approval, IRS tax-free ruling and Ralcorp Holdings, Inc. shareholder approvals. To date, the anti-trust approval has been obtained. We expect this transaction to be completed in mid-2008.

 

   

Immediately following the Distribution, we announced a new $5.0 billion, two-year share repurchase program. It replaced our previous $2.0 billion share repurchase program. During 2007, we repurchased 110.1 million shares of our Common Stock for approximately $3.6 billion under our share repurchase programs.

 

   

In August 2007, we issued $3.5 billion of senior unsecured notes, and in December 2007, we issued an additional $3.0 billion of senior unsecured notes. We used the net proceeds (approximately $3,462 million in August and $2,966 million in December) for general corporate purposes, including the repayment of outstanding commercial paper and a portion of the bridge facility used to fund our Danone Biscuit acquisition.

 

   

In the third quarter of 2007, our Board of Directors approved an 8.0% increase in the current quarterly dividend rate to $0.27 per share on our Common Stock. As a result, our current annualized dividend rate is $1.08 per share of Common Stock.

 

18


Discussion and Analysis

Growth Strategy

At the Consumer Analyst Group of New York (“CAGNY”) Conference in February 2008, we presented the progress we made in 2007 on our long-term growth strategy and our plans for the second year of our three-year plan to return Kraft to reliable growth. Our four growth strategies and 2007 developments are summarized below.

Rewire the organization for growth - We made significant changes to our incentive systems, senior management team and organizational structure. Our annual bonuses and long-term incentive plans are now tied to measures that our people can control and that will increase shareholder value such as operating income growth. We also complemented our veteran Kraft management team by adding new talent. In February 2008, we announced the implementation of our new operating structure built on three core elements: business units now have full P&L accountability and are staffed accordingly; shared services that leverage the scale of our global portfolio; and a streamlined corporate staff.

Reframe our categories - We are utilizing the concept of the “Growth Diamond” to focus on four key consumer trends driving category growth: Snacking; Quick Meals; Health and Wellness; and Premium.

We also reframed our portfolio through acquisitions and divestitures. In 2007, we divested our flavored water and juice brand assets and related trademarks, including Veryfine and Fruit2O, and acquired the Danone Biscuit business. These changes will result in increased revenues being derived from Kraft International. We also announced the planned merger of the Post Business into Ralcorp, which we anticipate will be completed in mid-2008.

Exploit our sales capabilities - We are using our large scale as a competitive advantage as we better leverage our portfolio. Our “Wall-to-Wall” initiative for Kraft North America combined the executional benefits of direct store delivery used in our Biscuit business unit with the economics of our warehouse delivery to drive faster growth. Wall-to-Wall will increase the frequency of our retail visits and build stronger, ongoing relationships with store management allowing us to: reduce out-of-stocks; get new items to the shelves more quickly; and increase the number and quality of displays. We plan to complete the full rollout in North America by mid-2008.

We plan to build profitable scale by expanding our distribution reach in countries with rapidly growing demand. The acquisition of Danone Biscuit is part of our efforts to expand our reach in developing markets.

Drive down costs without compromising quality - We plan to contain administrative overhead costs while investing in quality, R&D, marketing, sales and other capabilities that support growth. We are incrementally investing $100 million into quality upgrades in 2008. Additionally, we anticipate completing our Restructuring Program in 2008 with total annualized savings reaching $1.2 billion by the end of 2009.

 

19


Summary of Financial Results

The following tables show the significant changes in our net earnings and diluted EPS between 2007 and 2006, and between 2006 and 2005 (in millions, except per share data):

 

     Earnings from
Continuing
Operations
    Diluted EPS from
Continuing
Operations
 

For the year ended December 31, 2006

   $ 3,060     $ 1.85  

2007 Losses on divestitures, net

     (3 )     -  

2006 Gains on divestitures, net

     (31 )     (0.02 )

2006 Gain on redemption of United Biscuits investment

     (148 )     (0.09 )

2007 Restructuring Program

     (303 )     (0.19 )

2006 Restructuring Program

     444       0.27  

European Union segment reorganization

     (7 )     -  

2007 Asset impairment charges

     (52 )     (0.03 )

2006 Asset impairment charges

     284       0.17  

Change in effective tax rate

     13       0.01  

Interest from tax reserve transfers from Altria Group, Inc.

     49       0.03  

2006 favorable resolution of the Altria Group, Inc. 1996-1999 IRS Tax Audit

     (405 )     (0.24 )

Change in shares outstanding

     -       0.07  

Decrease in operations

     (311 )     (0.21 )
                

For the year ended December 31, 2007

   $ 2,590     $ 1.62  
                
     Earnings from
Continuing
Operations
    Diluted EPS from
Continuing
Operations
 

For the year ended December 31, 2005

   $ 2,904     $ 1.72  

2006 Gains on divestitures, net

     31       0.02  

2005 Gains on divestitures, net

     (65 )     (0.04 )

2006 Gain on redemption of United Biscuits investment

     148       0.09  

2006 Restructuring Program

     (444 )     (0.27 )

2005 Restructuring Program

     199       0.12  

2006 Asset impairment charges

     (284 )     (0.17 )

2005 Asset impairment charges

     140       0.08  

Change in effective tax rate

     (66 )     (0.04 )

2006 favorable resolution of the Altria Group, Inc. 1996-1999 IRS Tax Audit

     405       0.24  

Change in shares outstanding

     -       0.04  

Increase in operations

     92       0.06  
                

For the year ended December 31, 2006

   $ 3,060     $ 1.85  
                

See below for a discussion of those events affecting comparability and a discussion of operating results.

Acquisitions and Divestitures

Danone Biscuit:

On November 30, 2007, we acquired the global biscuit business of Groupe Danone S.A. (“Danone Biscuit”) for €5.1 billion (approximately $7.6 billion) in cash subject to purchase price adjustments. On October 12, 2007, we entered into a 364-day bridge facility agreement, and at closing, we borrowed €5.1 billion under that facility in order to finance the acquisition. The acquisition included 32 manufacturing facilities and approximately 14,000 employees. Danone Biscuit generated global revenues of approximately $2.8 billion during 2007. Danone Biscuit will report results from operations on a one month lag; as such, there was no impact on our operating results in 2007. On a proforma basis, Danone Biscuit’s net earnings for the year ended December 31, 2007 would have been insignificant to Kraft.

 

20


We acquired assets consisting primarily of goodwill of $5,239 million (which will not be deductible for statutory tax purposes), intangible assets of $2,196 million (substantially all of which are expected to be indefinite lived), property, plant and equipment of $561 million, receivables of $759 million and inventories of $198 million. These amounts represent the preliminary allocation of purchase price and are subject to revision when appraisals are finalized, which will occur during 2008.

United Biscuits:

In 2006, we acquired the Spanish and Portuguese operations of United Biscuits (“UB”) for approximately $1.1 billion. The non-cash acquisition was financed by our assumption of $541 million of debt issued by the acquired business immediately prior to the acquisition, as well as $530 million of value for the redemption of our outstanding investment in UB, primarily deep-discount securities. The redemption of our outstanding investment resulted in a gain on closing of approximately $251 million, or $0.09 per diluted share, in the third quarter of 2006. As part of the transaction, we also recovered the rights to all Nabisco trademarks in the European Union, Eastern Europe, the Middle East and Africa, which UB had held since 2000. The Spanish and Portuguese operations of UB include its biscuits, dry desserts and canned meats, tomato and fruit juice businesses. The operations also include seven manufacturing facilities and 1,300 employees. These businesses contributed net revenues of approximately $466 million for the year ended December 31, 2007 and approximately $111 million for the period from September 2006 to December 31, 2006.

We acquired assets consisting primarily of goodwill of $730 million, intangible assets of $217 million, property, plant and equipment of $149 million, receivables of $101 million and inventories of $34 million.

Post Distribution:

On November 15, 2007, we announced a definitive agreement to merge our Post cereals business (“Post Business”) into Ralcorp Holdings, Inc. (“Ralcorp”) after a tax-free distribution to our shareholders (the “Post Distribution”). We have signed an agreement with Ralcorp to execute the Post Distribution by means of a “Reverse-Morris Trust” transaction. This transaction is subject to customary closing conditions, including anti-trust approval, IRS tax-free ruling and Ralcorp shareholder approvals. To date, the anti-trust approval has been obtained. We anticipate that this transaction will be completed in mid-2008.

The Post Business had net revenues of approximately $1.1 billion in 2007, and includes such cereals as Honey Bunches of Oats, Pebbles, Shredded Wheat, Selects, Grape Nuts and Honeycomb. The brands in this transaction are distributed primarily in North America. In addition to the Post brands, the transaction includes four manufacturing facilities and certain manufacturing equipment. We anticipate that approximately 1,250 employees will join Ralcorp following the consummation of the transaction.

Our shareholders will receive at least 30.3 million shares of Ralcorp stock after the Post Distribution and the subsequent merger of the Post Business with Ralcorp. Based on market conditions prior to closing, we will determine whether the shares will be distributed in a spin-off or a split-off transaction. Either type of transaction is expected to be tax-free to our U.S. shareholders. In a spin-off transaction, our shareholders would receive a pro rata number of Ralcorp shares. In a split-off transaction, our shareholders would have the option to exchange their Kraft shares and receive Ralcorp shares at closing, resulting in a reduction in the number of shares of our Common Stock outstanding. In addition, Kraft will receive approximately $960 million of cash-equivalent value, which will be used to repay debt.

Other:

In 2007, we received $216 million in proceeds, and recorded pre-tax gains of $15 million on the divestitures of our hot cereal assets and trademarks, our sugar confectionery assets in Romania and related trademarks and our flavored water and juice brand assets and related trademarks, including Veryfine and Fruit2O. We recorded an after-tax loss of $3 million on these divestitures, which reflects the differing book and tax bases of our hot cereal assets and trademarks divestiture.

In 2006, we received $946 million in proceeds, and recorded pre-tax gains of $117 million on the divestitures of our pet snacks brand and assets, rice brand and assets, certain Canadian assets, our industrial coconut assets, a small U.S. biscuit brand and a U.S. coffee plant. We recorded after-tax gains of $31 million, or $0.02 per diluted share, on these divestitures, which reflects the tax expense of $57 million related to the differing book and tax bases on our pet snacks brand and assets divestiture.

In 2005, we received $238 million in proceeds, and recorded pre-tax gains of $108 million, or $0.04 per diluted share, on the divestitures of our fruit snacks assets, our U.K. desserts assets, our U.S. yogurt assets, a small operation in Colombia, a minor trademark in Mexico and a small equity investment in Turkey.

We also sold substantially all of our sugar confectionery business in June 2005 for pre-tax proceeds of approximately $1.4 billion. The sale included the Life Savers, Creme Savers, Altoids, Trolli and Sugus brands. We reflected the results of our

 

21


sugar confectionery business prior to the closing date as discontinued operations on the consolidated statements of earnings. We recorded a loss on sale of discontinued operations of $272 million in 2005, related largely to taxes on the transaction.

These (gains) / losses on divestitures were included in segment operating income as follows:

 

         For the Years Ended
December 31,
 
         2007      2006      2005  
         (in millions)  
 

North America Beverages

   $ 5      $ 95      $ -  
 

North America Cheese & Foodservice

     -        8        (1 )
 

North America Convenient Meals

     -           (226 )      -  
 

North America Grocery

     -        1        2  
 

North America Snacks & Cereals

          (12 )      5        -  
 

European Union

     -        -           (114 )
 

Developing Markets (1)

     (8 )      -        5  
                            
 

Gains on divestitures, net

   $ (15 )    $ (117 )    $ (108 )
                            
 

(1)    This segment was formerly known as Developing Markets, Oceania & North Asia

      

These gains and losses on divestitures do not reflect the related asset impairment charges discussed below.

The aggregate operating results of the acquisitions and divestitures discussed above, other than the UB acquisition, and the divestiture of the sugar confectionery business, were not material to our financial statements in any of the periods presented.

Restructuring Program

In January 2004, we announced a three-year restructuring program (the “Restructuring Program”) and, in January 2006, extended it through 2008. The objectives of this program are to leverage our global scale, realign and lower our cost structure, and optimize capacity. As part of the Restructuring Program we anticipate:

 

   

incurring approximately $2.8 billion in pre-tax charges reflecting asset disposals, severance and implementation costs;

   

closing at least 35 facilities and eliminating approximately 13,500 positions;

   

using cash to pay for approximately $1.7 billion of the $2.8 billion in charges; and

   

cumulative, annualized savings reaching $1.2 billion by the end of 2009.

In February 2008, we announced the implementation of our new operating structure built on three core elements: accountable business units; shared services that leverage the scale of our global portfolio; and a streamlined corporate staff. Within our new structure, business units now have full P&L accountability and are staffed accordingly. This also ensures that we are putting our resources closer to where decisions are made that affect our consumers. Our corporate and shared service functions are streamlining their organizations and focusing them on core activities that can more efficiently support the goals of the business units. The intent was to simplify, streamline and increase accountability, with the ultimate goal of generating reliable growth for Kraft. As a result, we have eliminated approximately 700 positions as we streamline our headquarters functions.

We incurred charges under the Restructuring Program of $459 million in 2007, or $0.19 per diluted share; $673 million in 2006, or $0.27 per diluted share; and $297 million in 2005, or $0.12 per diluted share. Since the inception of the Restructuring Program, we have incurred $2.1 billion in charges, and paid cash for $1.1 billion. We announced the closure of three plants during 2007; we have now announced the closure of 30 facilities since the program began in 2004. In connection with our severance initiatives, we have eliminated approximately 11,000 positions as of December 31, 2007; at that time we had announced the elimination of an additional 400 positions.

Under the Restructuring Program, we recorded asset impairment and exit costs of $332 million during 2007, $578 million during 2006 and $210 million during 2005. We recorded implementation costs of $127 million in 2007, $95 million in 2006 and $87 million in 2005. Implementation costs are directly attributable to exit costs; however they do not qualify for treatment under Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These costs primarily include the discontinuance of certain product lines, incremental expenses related to the closure of facilities and the Electronic Data Systems (“EDS”) transition discussed in Note 2 to the consolidated financial statements.

 

22


Management believes the disclosure of implementation charges provides readers of our financial statements greater transparency to the total costs of our Restructuring Program.

In addition, we expect to spend approximately $550 million in capital to implement the Restructuring Program. We have spent $387 million in capital since the inception of the Restructuring Program, including $142 million spent in 2007. Cumulative annualized cost savings resulting from the Restructuring Program were approximately $540 million through 2006. Incremental cost savings totaled approximately $243 million in 2007, resulting in cumulative annualized savings under the Restructuring Program of approximately $783 million to date. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for further details of our Restructuring Program.

European Union Segment Reorganization

We are also in the process of reorganizing our European Union segment to function on a pan-European centralized category management and value chain model. After the reorganization is complete, the European Principal Company (“EPC”) will manage the European Union segment categories centrally and make decisions for all aspects of the value chain, except for sales and distribution. The European subsidiaries will execute sales and distribution locally, and the local production companies will act as toll manufacturers on behalf of the EPC. The EPC legal entity has already been incorporated as Kraft Foods Europe GmbH in Zurich, Switzerland.

As part of this reorganization, we incurred $21 million of restructuring costs, $24 million of implementation costs and $10 million of other non-recurring costs during 2007, and incurred $7 million of restructuring costs during 2006. Restructuring and implementation costs are recorded as part of our overall Restructuring Program. Other costs relating to our European Union segment reorganization are recorded as marketing, administration and research costs. Management believes the disclosure of implementation and other non-recurring charges provides readers of our financial statements greater transparency to the total costs of our European Union segment reorganization.

Asset Impairment Charges

During the first and fourth quarters of 2007, we completed our annual review of goodwill and intangible assets. No impairments resulted from these reviews. Additionally, in 2007, we sold our flavored water and juice brand assets and related trademarks, and incurred an asset impairment charge of $120 million, or $0.03 per diluted share, in recognition of the sale. The charge, which included the write-off of the associated goodwill of $3 million, intangible assets of $70 million and property, plant and equipment of $47 million, was recorded as asset impairment and exit costs on the consolidated statement of earnings.

We recorded aggregate asset impairment charges in 2006 amounting to $424 million, or $0.17 per diluted share. During our 2006 annual review of goodwill and intangible assets we recorded a $24 million non-cash charge for impairment of biscuits assets in Egypt and hot cereal assets in the U.S. In addition, we incurred an asset impairment charge of $69 million in 2006 in anticipation of the 2007 sale of our hot cereal assets and trademarks. The charge included the write-off of a portion of the associated goodwill of $15 million, intangible assets of $52 million and property, plant and equipment of $2 million. No further charges were incurred in 2007 related to this sale. Additionally, in 2006, we incurred an asset impairment charge of $86 million in recognition of the pet snacks brand and assets sale. The charge included the write-off of a portion of the associated goodwill of $25 million, intangible assets of $55 million and property, plant and equipment of $6 million. Also during 2006, we re-evaluated the business model for our Tassimo hot beverage system due to lagging revenues. This evaluation resulted in a $245 million non-cash asset impairment charge from lower utilization of existing manufacturing capacity. We recorded these charges as asset impairment and exit costs on the consolidated statement of earnings.

We recorded aggregate asset impairment charges in 2005 amounting to $269 million, or $0.08 per diluted share. During the first quarter of 2005, we completed our annual review of goodwill and intangible assets. No impairments resulted from this review. In addition, we sold our fruit snacks assets during 2005 and incurred an asset impairment charge of $93 million in recognition of the sale. We also incurred asset impairment charges of $176 million in 2005 in anticipation of the 2006 sales of certain assets in Canada and a small biscuit brand in the U.S. These aggregate charges, which included the write-off of the associated goodwill of $13 million, intangible assets of $118 million and asset write-downs of $138 million were recorded as asset impairment and exit costs on the consolidated statement of earnings. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for further asset impairment details.

 

23


Provision for Income Taxes

Our tax rate was 30.5% in 2007, 23.7% in 2006 and 29.4% in 2005. Our 2007 effective tax rate includes $184 million in favorable tax rate items, primarily including the effects of dividend repatriation benefits, foreign earnings taxed below the U.S. federal statutory tax rate, foreign joint venture earnings, and the effect on foreign deferred taxes from lower foreign tax rates enacted in 2007, partially offset by other foreign tax expense items. The 2007 tax rate also benefited from an increased domestic manufacturing deduction and the divestiture of our flavored water and juice brand assets and related trademarks. These benefits were partially offset by state tax expense.

During 2006, the IRS concluded its examination of Altria’s consolidated tax returns for the years 1996 through 1999. The IRS issued a final Revenue Agents Report on March 15, 2006. Consequently, Altria reimbursed us $337 million for federal tax reserves that were no longer necessary and $46 million for interest ($29 million net of tax). We also recognized net state tax reversals of $39 million, for a total tax provision benefit of $376 million ($337 million federal plus $39 million state). The total benefit to net earnings that we recognized in 2006 due to the IRS settlement was $405 million, or $0.24 per diluted share. The 2006 tax rate also benefited from the resolution of various tax items in our foreign operations, dividend repatriation benefits, joint venture earnings, and lower foreign tax rates enacted in 2006 (primarily Canada). These benefits were partially offset by state tax expense and by the tax costs associated with our 2006 divestitures.

The 2005 effective tax rate includes tax benefits of $117 million from dividend repatriation including the impact from the American Jobs Creation Act of 2004, the resolution of outstanding items in our international operations, and the settlement of an outstanding U.S. tax claim. The 2005 tax rate also benefited from our 2005 divestitures, which was partially offset by state tax expense.

As discussed in Note 1, Summary of Significant Accounting Policies, Altria transferred our federal tax contingencies of $375 million to our balance sheet and related interest income of $77 million, or $0.03 per diluted share, as a result of the Distribution. Following the Distribution, we are no longer a member of the Altria consolidated tax return group, and we will file our own federal consolidated income tax return. We continue to assess opportunities to mitigate the loss of tax benefits as a result of filing separately, and currently estimate the annual amount of lost tax benefits to be in the range of $50 million to $75 million, as compared to 2007.

Consolidated Results of Operations

The following discussion compares our consolidated operating results for 2007 with 2006, and for 2006 with 2005.

Many factors impact the timing of sales to our customers. These factors include, among others, the timing of holidays and other annual or special events, seasonality, significant weather conditions, timing of our own or customer incentive programs and pricing actions, customer inventory programs and general economic conditions. Our domestic operating subsidiaries report year-end results as of the Saturday closest to the end of each year, and our international operating subsidiaries generally report year-end results two weeks prior to the Saturday closest to the end of each year. This resulted in 53 weeks of operating results in our consolidated statement of earnings for the year ended December 31, 2005, versus 52 weeks for the years ended December 31, 2007 and 2006.

 

       For the Years Ended
December 31,
     $ change        % change  
       2007      2006          
      

(in millions, except

per share data)

                 

Net revenues

     $  37,241      $  34,356      $    2,885        8.4 %
                           

Operating income

       4,331        4,521        (190 )      (4.2 %)
                           

Net earnings

       2,590        3,060        (470 )      (15.4 %)
                           

Diluted earnings per share

     $ 1.62      $ 1.85        (0.23 )      (12.4 %)
                           

 

24


       For the Years Ended
December 31,
       $ change        % change  
       2006      2005            
      

(in millions, except

per share data)

                   

Net revenues

     $  34,356      $  34,113        $ 243        0.7 %
                             

Operating income

       4,521        4,749          (228 )      (4.8 %)
                             

Earnings from continuing operations

       3,060        2,904          156        5.4 %
                             

Loss from discontinued operations, net of

income taxes

       -        (272 )        272        (100.0 %)
                             

Net earnings

       3,060        2,632          428        16.3 %
                             

Diluted earnings per share

     $ 1.85      $ 1.55          0.30        19.4 %
                             

2007 compared with 2006:

Net Revenues - Net revenues increased $2,885 million (8.4%), due primarily to favorable currency (3.2 pp), favorable mix (1.8 pp), higher volume (1.7 pp), higher net pricing (1.6 pp) and the impact of acquisitions (1.0 pp), partially offset by the impact of divestitures (0.9 pp). Currency fluctuations increased net revenues by $1,070 million, due primarily to the continuing weakness of the U.S. dollar against the euro and Canadian dollar. Total volume increased 1.3% (net of 0.4 pp due to divestitures offset by acquisitions), driven by higher shipments in the European Union (due to the UB acquisition) and Developing Markets, partially offset by lower volume in all North American segments due primarily to the impact of divestitures, declines in certain grocery products and the discontinuation of select lower margin foodservice products.

Operating Income - Operating income declined $190 million (4.2%), due primarily to higher total manufacturing costs, including higher commodity costs, net of the impact of higher pricing ($533 million), higher marketing, administration and research costs ($338 million, including higher marketing support), an asset impairment charge related to our flavored water and juice brand assets and related trademarks ($120 million), the impact of divestitures ($105 million), the prior year $251 million gain on the redemption of our UB investment, and the prior year $226 million gain on the divested rice assets and trademarks. These items were partially offset by favorable volume/mix ($475 million), 2006 asset impairment charges related to the divested pet snacks and hot cereal assets and trademarks, Tassimo hot beverage system and biscuits assets in Egypt (totaling $424 million), lower Restructuring Program charges ($214 million) and the 2006 loss on the sale of a U.S. coffee plant ($95 million). Currency fluctuations increased operating income by $125 million due primarily to the continuing weakness of the U.S. dollar against the euro and Canadian dollar.

Net Earnings - Net earnings of $2,590 million decreased by $470 million (15.4%), due primarily to operating income declines, a favorable tax rate in 2006 from a significant tax resolution, and higher interest expense.

Earnings per Share - Diluted earnings per share were $1.62, down 12.4% from $1.85 in 2006.

In 2007, we incurred $0.19 per diluted share ($459 million before taxes) in Restructuring Program costs as compared to $0.27 per diluted share ($673 million before taxes) in 2006. Additionally, in 2007, we incurred $0.03 per diluted share ($120 million before taxes) in asset impairment charges as compared to $0.17 per diluted share ($424 million before taxes) in 2006. Due to the Distribution, we recognized interest income of $0.03 per diluted share ($77 million before taxes) from tax reserve transfers from Altria.

In 2006, we benefited from favorable federal and state tax resolutions amounting to $405 million, or $0.24 per diluted share. Additionally, in 2006, we benefited from a $0.09 per diluted share gain on the redemption of our UB investment and $0.02 per diluted share net gain on divestitures. Lastly, we benefited $.07 per diluted share due to the 2007 share repurchase activity.

2006 compared with 2005:

Our 2005 results included 53 weeks of operating results compared with 52 weeks in 2006. We estimate that this extra week positively impacted net revenues and operating income by approximately 2% in 2005 (approximately $625 million and $100 million, respectively).

 

25


Net Revenues - Net revenues increased $243 million (0.7%), due primarily to favorable volume/mix (0.7pp, including the 53rd week in 2005), higher net pricing (0.7pp), favorable currency (0.5 pp) and the impact of acquisitions (0.3pp), partially offset by the impact of divestitures (1.5pp). Currency fluctuations increased net revenues by $145 million due primarily to the weakness of the U.S. dollar against the Canadian dollar and the Brazilian real, partially offset by the strength of the U.S. dollar against the euro. Volume decreased 961 million pounds (5.0%), including the 53rd week in 2005 results. Excluding the impact of divestitures, the acquisition of UB and the 53rd week of shipments in 2005, volume decreased 0.4%, due primarily to the discontinuation of certain ready-to-drink and foodservice product lines and lower grocery shipments in North America, partially offset by higher shipments of meat, biscuits and cheese in North America and higher shipments in Developing Markets.

Operating Income - Operating income declined $228 million (4.8%), due primarily to higher Restructuring Program costs ($376 million), higher asset impairment charges ($155 million), 2005 net gains on divestitures ($108 million), higher marketing, administrative and research costs ($78 million), and the impact of divestitures ($71 million). These impacts were partially offset by the 2006 gain on redemption of our UB investment ($251 million), the 2006 net gains on divestitures ($117 million), higher pricing, net of increased promotional spending and higher input costs ($72 million), lower fixed manufacturing costs ($40 million), favorable volume/mix ($32 million, including the 53rd week in 2005) and the acquisition of UB ($18 million). Currency fluctuations increased operating income by $29 million due primarily to the weakness of the U.S. dollar against the Canadian dollar and the Brazilian real, partially offset by the strength of the U.S. dollar against the euro.

Earnings from Continuing Operations - Earnings from continuing operations of $3,060 million increased $156 million (5.4%), due primarily to a favorable tax rate resulting from a significant tax resolution in 2006 and lower interest expense, partially offset by lower operating income.

Loss from discontinued operations - In June 2005, we sold substantially all of our sugar confectionery business for proceeds of approximately $1.4 billion. We reflected the results of our sugar confectionery business prior to the closing date as discontinued operations on the consolidated statements of earnings. We recorded a loss on sale of discontinued operations of $272 million in 2005, related largely to taxes on the transaction.

Net Earnings - Net earnings of $3,060 million increased $428 million (16.3%) due to increased earnings from continuing operations and the 2005 loss from discontinued operations.

Earnings per Share - Diluted earnings per share were $1.85, up 19.4% from $1.55 in 2005.

In 2006, we incurred $0.27 per diluted share ($673 million before taxes) in Restructuring Program costs as compared to $0.12 per diluted share ($297 million before taxes) in 2005. Additionally, in 2006, we incurred $0.17 per diluted share ($424 million before taxes) in asset impairment charges as compared to $0.08 per diluted share ($269 million before taxes) in 2005. In 2006, we also benefited from favorable federal and state tax resolutions amounting to $405 million, or $0.24 per diluted share. Additionally, in 2006, we benefited from a $0.09 per diluted share gain on the redemption of our UB investment and $0.02 per diluted share net gain on divestitures as compared to a $0.04 per diluted share net gain on divestitures in 2005. Lastly, we benefited $.04 per diluted share due to the 2006 share repurchase activity.

Results of Operations by Business Segment

We manage and report operating results through two commercial units, Kraft North America and Kraft International. We manage Kraft North America’s operations by product category, and Kraft International’s operations by geographic location.

Kraft North America’s segments are North America Beverages; North America Cheese & Foodservice; North America Convenient Meals; North America Grocery; and North America Snacks & Cereals. The two international segments are European Union; and Developing Markets (formerly known as Developing Markets, Oceania & North Asia), the latter to reflect our increased management focus on developing markets.

 

26


The following discussion compares our operating results for each of our reportable segments for 2007 with 2006, and for 2006 with 2005.

 

     For the Years Ended
December 31,
 
     2007      2006      2005  
     (in millions)  

Net revenues:

        

North America Beverages

   $ 3,235      $ 3,088      $ 3,056  

North America Cheese & Foodservice

     6,382        6,078        6,244  

North America Convenient Meals

     5,097        4,863        4,719  

North America Grocery

     2,699        2,731        3,024  

North America Snacks & Cereals

     6,526        6,358        6,250                                                       

European Union

     7,954        6,672        6,714  

Developing Markets

     5,348        4,566        4,106  
                          

Net revenues

   $  37,241      $  34,356      $  34,113  
                          
     For the Years Ended
December 31,
 
     2007      2006      2005  
     (in millions)  

Operating income:

        

Segment operating income:

        

North America Beverages

   $ 337      $ 205      $ 463  

North America Cheese & Foodservice

     621        886        921  

North America Convenient Meals

     695        914        793  

North America Grocery

     817        919        724  

North America Snacks & Cereals

     1,018        829        930  

European Union

     571        548        722  

Developing Markets

     491        416        400  

General corporate expenses

     (206 )      (189 )      (194 )

Amortization of intangibles

     (13 )      (7 )      (10 )
                          

Operating income

   $ 4,331      $ 4,521      $ 4,749  
                          

As discussed in Note 16 to the consolidated financial statements, Segment Reporting, our management uses segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes unallocated general corporate expenses and amortization of intangibles. Management believes it is appropriate to disclose this measure to help investors analyze segment performance and trends. We incurred asset impairment, exit and implementation costs of $579 million in 2007, $1,097 million in 2006 and $566 million in 2005. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for a breakout of charges by segment.

North America Beverages

       For the Years Ended
December 31,
   $ change     % change  
       2007    2006     
       (in millions)             

Net revenues

     $ 3,235    $          3,088    $         147     4.8 %                                  

Segment operating income

       337      205      132     64.4 %
       For the Years Ended
December 31,
   $ change     % change  
       2006    2005     
       (in millions)             

Net revenues

     $  3,088    $ 3,056    $ 32     1.0 %

Segment operating income

       205      463      (258 )   (55.7 %)

 

27


2007 compared with 2006:

Net revenues increased $147 million (4.8%), due primarily to favorable mix (2.9 pp), higher volume (2.1 pp) and higher net pricing (0.9 pp), which were partially offset by the impact of divestitures (1.5 pp). Favorable mix from Crystal Light On the Go sticks and premium coffee partially drove higher net revenues. Higher volume was driven by ready-to-drink beverages, primarily Capri Sun, partially offset by lower shipments of powdered beverages and Maxwell House coffee. Higher commodity-based pricing in coffee was partially offset by increased promotional spending in ready-to-drink beverages and powdered beverages.

Segment operating income increased $132 million (64.4%), due primarily to the 2006 loss on the sale of a U.S. coffee plant, the 2006 asset impairment charge related to Tassimo hot beverage system, favorable volume/mix and lower marketing expense. These favorabilities were partially offset by an asset impairment charge related to our flavored water and juice brand assets and related trademarks and higher total manufacturing costs, including higher commodity costs (primarily related to coffee and packaging), net of higher pricing.

2006 compared with 2005:

Net revenues increased $32 million (1.0%), due primarily to favorable mix (6.2 pp), higher net pricing (1.2 pp) and favorable currency (0.5 pp), partially offset by lower volume (6.8 pp, including the 53rd week in 2005). Coffee net revenues increased due to higher commodity-based pricing, partially offset by lower shipments. In powdered beverages, favorable mix from new products also drove higher net revenues. Ready-to-drink net revenues declined due to lower shipments and discontinuation of certain products.

Segment operating income decreased $258 million (55.7%), due primarily to the loss on the sale of a U.S. coffee plant, an asset impairment charge related to Tassimo hot beverage system, higher commodity costs and higher Restructuring Program costs, partially offset by higher pricing.

North America Cheese & Foodservice

       For the Years Ended
December 31,
     $ change      % change  
           2007              2006            
       (in millions)                

Net revenues

     $ 6,382      $ 6,078      $ 304      5.0 %                                         

Segment operating income

       621        886        (265 )    (29.9 %)
       For the Years Ended
December 31,
     $ change      % change  
       2006      2005        
       (in millions)                

Net revenues

     $ 6,078      $ 6,244      $ (166 )    (2.7 %)

Segment operating income

       886        921        (35 )    (3.8 %)

2007 compared with 2006:

Net revenues increased $304 million (5.0%), due primarily to higher commodity-based net pricing (5.2 pp) and favorable currency (0.8 pp), partially offset by lower volume (0.8 pp). Cheese net revenues increased, driven by higher commodity-based pricing and favorable volume/mix, primarily from new product introductions. In foodservice, net revenues growth from higher commodity-based net pricing was partially offset by lower volume due to the discontinuation of lower margin product lines and unfavorable mix.

Segment operating income decreased $265 million (29.9%), due primarily to higher commodity costs and higher marketing, administration and research costs (including higher marketing support). These unfavorable variances were partially offset by higher pricing, lower Restructuring Program charges, favorable currency and a 2006 loss on the sale of industrial coconut assets.

2006 compared with 2005:

Net revenues decreased $166 million (2.7%), due to lower volume (2.2 pp, including the 53rd week in 2005), lower net pricing (1.8 pp) and the impact of divestitures (0.9 pp), partially offset by favorable mix (1.2 pp) and favorable currency (1.0 pp). In

 

28


foodservice, net revenues decreased due primarily to lower volume, the impact of divestitures and lower cheese pricing, partially offset by favorable currency. Cheese net revenues decreased due primarily to lower net pricing in response to declining cheese costs and the impact of divestitures, partially offset by favorable currency.

Segment operating income decreased $35 million (3.8%), due primarily to higher Restructuring Program charges, lower volume/mix (including the 53rd week in 2005), higher marketing spending and the 2006 loss on sale of industrial coconut assets, partially offset by favorable costs (primarily cheese commodity costs), net of lower net pricing, lower fixed manufacturing costs and favorable currency.

North America Convenient Meals

       For the Years Ended
December 31,
     $ change      % change  
           2007              2006            
       (in millions)                

Net revenues

     $ 5,097      $ 4,863      $ 234      4.8 %                                         

Segment operating income

       695        914        (219 )    (24.0 %)
       For the Years Ended
December 31,
     $ change      % change  
       2006      2005        
       (in millions)                

Net revenues

     $ 4,863      $ 4,719      $ 144      3.1 %

Segment operating income

       914        793        121      15.3 %

2007 compared with 2006:

Net revenues increased $234 million (4.8%), due primarily to favorable mix (2.7 pp), higher volume (2.5 pp) and higher net pricing (1.0 pp), partially offset by the impact of divestitures (1.7 pp). Net revenues increased in meat due to higher shipments of sandwich meat, new product introductions and higher commodity-based net pricing, partially offset by lower shipments of chicken strips due to a first quarter recall. In pizza, net revenues increased due to the introduction of DiGiorno Ultimate and higher shipments of California Pizza Kitchen products. Macaroni and cheese net revenues increased due to higher net pricing, higher volume due to base growth and favorable mix reflecting the continued success of Kraft Easy-Mac cups.

Segment operating income decreased $219 million (24.0%), due primarily to the 2006 gain on the divested rice assets and trademarks, higher commodity costs, the impact of divestitures and higher marketing, administration and research costs (including higher marketing support), which were partially offset by lower Restructuring Program charges, favorable volume/mix and higher pricing.

2006 compared with 2005:

Net revenues increased $144 million (3.1%), due to favorable mix (1.8 pp), higher volume (1.1 pp, including the 53rd week in 2005), favorable currency (0.3 pp) and higher net pricing (0.2 pp), partially offset by the impact of divestitures (0.3 pp). In meats, higher net revenues were driven by continued strong results for new products and higher net pricing. Pizza net revenues increased due to higher shipments and favorable mix from new products, partially offset by higher promotional spending. Dinners net revenues decreased due to the impact of lower volume.

Segment operating income increased $121 million (15.3%), due primarily to the gain on the sale of the rice brand and assets, lower fixed manufacturing costs, favorable currency and higher net pricing, partially offset by higher Restructuring Program charges, higher product costs and the impact of divestitures.

 

29


North America Grocery

       For the Years Ended
December 31,
     $ change      % change  
           2007              2006            
       (in millions)                

Net revenues

     $ 2,699      $ 2,731      $ (32 )    (1.2 %)

Segment operating income

       817        919        (102 )    (11.1 %)                                
       For the Years Ended
December 31,
     $ change      % change  
       2006      2005        
       (in millions)                

Net revenues

     $ 2,731      $ 3,024      $ (293 )    (9.7 %)

Segment operating income

       919        724        195      26.9 %

2007 compared with 2006:

Net revenues decreased $32 million (1.2%), due primarily to lower volume (1.8 pp) and unfavorable mix (0.8 pp), partially offset by higher net pricing (1.1 pp) and favorable currency (0.6 pp). The impact of lower shipments in spoonable and pourable salad dressings, barbeque sauce and dry packaged desserts was partially offset by higher net pricing in spoonable salad dressings and dry packaged desserts.

Segment operating income decreased $102 million (11.1%), due primarily to higher commodity costs, higher Restructuring Program costs and unfavorable volume/mix, partially offset by higher pricing.

2006 compared with 2005:

Net revenues decreased $293 million (9.7%), due to the impact of divestitures (8.6 pp) and lower volume (3.6 pp, including the 53rd week in 2005), partially offset by higher pricing (1.1 pp), favorable currency (0.9) and favorable mix (0.5 pp). Ready-to-eat and dry packaged desserts net revenues declined due to lower shipment volume. In spoonable salad dressing, net revenues decreased due to lower shipments, partially offset by lower promotional spending. Pourable salad dressing net revenues declined due to higher promotional spending.

Segment operating income increased $195 million (26.9%), due primarily to the 2005 asset impairment charges related to the divested Canadian grocery assets and fruit snacks assets, lower marketing, administration and research costs, favorable currency and higher pricing, net of unfavorable costs. These favorabilities were partially offset by unfavorable volume/mix and the impact of divestitures.

North America Snacks & Cereals

       For the Years Ended
December 31,
               
           2007              2006          $ change      % change  
       (in millions)                

Net revenues

     $ 6,526      $ 6,358      $ 168      2.6 %

Segment operating income

       1,018        829        189      22.8 %
       For the Years Ended
December 31,
               
           2006              2005          $ change      % change  
       (in millions)                

Net revenues

     $ 6,358      $ 6,250      $ 108      1.7 %

Segment operating income

       829        930        (101 )    (10.9 %)                                

2007 compared with 2006:

Net revenues increased $168 million (2.6%), due primarily to higher volume (2.3 pp) and favorable mix (2.0 pp), partially offset by the impact of divestitures (2.2 pp). Favorable mix and higher shipments in cookies and crackers due to new product introductions (including Oreo Cakesters) drove higher net revenues. Snack bars net revenues increased due to new product introductions and continued success of South Beach Living bars. Snack nuts net revenues increased due to favorable mix and new product introductions.

 

30


Segment operating income increased $189 million (22.8%), due primarily to 2006 asset impairment charges related to the divested pet snacks and hot cereal assets and trademarks, favorable volume/mix and lower Restructuring Program charges. These favorable variances were partially offset by higher marketing, administration and research costs (including higher marketing support) and the impact of divestitures.

2006 compared with 2005:

Net revenues increased $108 million (1.7%), due to favorable volume/mix (1.8 pp, including the 53rd week in 2005), higher net pricing (1.4 pp) and favorable currency (0.6 pp), partially offset by the impact of divestitures (2.1 pp). Biscuit net revenues increased due to higher pricing to offset the impact of commodity cost increases in energy and packaging, higher shipment volume and favorable mix. In snack bars, net revenue increases were driven by new product introductions. Canadian snack net revenues also increased due to sales of co-manufactured products related to the 2005 divested confectionery business. Snack nuts net revenues decreased due to lower shipments.

Segment operating income decreased $101 million (10.9%), due primarily to asset impairment charges related to the divested pet snacks and hot cereal assets and trademarks, higher product costs, the impact of divestitures and higher Restructuring Program costs. These unfavorable items were partially offset by higher net pricing, the 2005 asset impairment charge in anticipation of the 2006 sale of a small U.S. biscuit brand, lower marketing spending and lower fixed manufacturing costs.

European Union

       For the Years Ended
December 31,
     $ change      % change  
           2007              2006            
       (in millions)                

Net revenues

     $ 7,954      $ 6,672      $ 1,282      19.2 %

Segment operating income

       571        548        23      4.2 %
       For the Years Ended
December 31,
     $ change      % change  
       2006      2005        
       (in millions)                

Net revenues

     $ 6,672      $ 6,714      $ (42 )    (0.6 %)

Segment operating income

       548        722        (174 )    (24.1 %)                                

2007 compared with 2006:

Net revenues increased $1,282 million (19.2%), due to favorable currency (10.5 pp), the impact of the UB acquisition (5.1 pp), higher volume (3.4 pp) and favorable mix (1.9 pp), partially offset by lower net pricing (1.7 pp). Volume related growth and favorable mix were driven by premium chocolate, due to new product introductions and promotional activities, and higher shipments in mainstream coffee and cheese. Lower net pricing reflects higher promotional spending in chocolate, cheese and coffee (primarily in Germany).

Segment operating income increased $23 million (4.2%), due primarily to the 2006 asset impairment charge related to Tassimo hot beverage system, favorable volume/mix, lower Restructuring Program charges, favorable currency, lower fixed manufacturing costs and the impact of the UB acquisition. Partially offsetting these favorable variances were the prior year gain on the redemption of our UB investment, higher commodity costs, lower net pricing and higher marketing expense.

2006 compared with 2005:

Net revenues decreased $42 million (0.6%), due to lower volume (1.7 pp, including the 53rd week in 2005), unfavorable currency (1.3 pp) and the impact of divestitures (0.2 pp), partially offset by the acquisition of UB (1.6 pp), favorable mix (0.9 pp) and higher net pricing (0.1 pp). Volume related declines, net of favorable mix, were driven by lower shipments in cheese, coffee and refreshment beverages. Net pricing was essentially flat as increased pricing in coffee and chocolate was offset by higher promotional spending across all categories.

Segment operating income decreased $174 million (24.1%), due primarily to the asset impairment charge related to Tassimo hot beverage system, the 2005 gain on divested U.K. desserts assets, higher Restructuring Program costs, unfavorable costs and increased promotional spending, net of higher pricing, higher marketing, administration and research costs and unfavorable

 

31


currency. These unfavorabilities were partially offset by the gain on the redemption of our UB investment, the impact of the UB acquisition and lower fixed manufacturing costs.

Developing Markets

           For the Years Ended
December 31,
     $ change      % change          
               2007              2006                  
           (in millions)                        
 

Net revenues

     $     5,348      $     4,566      $        782              17.1 %    
 

Segment operating income

       491        416        75      18.0 %    
           For the Years Ended
December 31,
     $ change      % change          
           2006      2005              
           (in millions)                        
 

Net revenues

     $ 4,566      $ 4,106      $ 460      11.2 %    
 

Segment operating income

       416        400        16      4.0 %    

2007 compared with 2006:

Net revenues increased $782 million (17.1%), due primarily to favorable currency (5.4 pp), higher net pricing (5.1 pp), higher volume (4.0 pp), and favorable mix (2.4 pp). In Eastern Europe, Middle East & Africa, net revenues increased due to higher pricing and growth in coffee and chocolate in Russia, Romania and Ukraine, and in refreshment beverages and snacks for the Middle East & Africa. In Latin America, net revenues increased due to higher pricing and favorable volume/mix, particularly in Brazil, Venezuela and Argentina. In Asia Pacific, net revenues increased due to volume growth in China and Southeast Asia.

Segment operating income increased $75 million (18.0%), due primarily to higher pricing, favorable volume/mix, lower Restructuring Program costs, favorable currency and a 2006 asset impairment charge related to the biscuits assets in Egypt. These favorable variances were partially offset by higher marketing, administration and research costs (including higher marketing support costs) and higher commodity costs.

2006 compared with 2005:

Net revenues increased $460 million (11.2%), due to favorable volume/mix (5.2 pp, including the 53rd week in 2005), higher pricing (4.4 pp) and favorable currency (2.1 pp), partially offset by the impact of divestitures (0.5 pp). In Eastern Europe, Middle East & Africa, net revenues increased due to volume growth and higher pricing in coffee and chocolate in Russia, Romania, Ukraine and Bulgaria. In Latin America, net revenues increased due to higher pricing and favorable volume/mix, particularly in Brazil, Venezuela and Argentina. In Asia Pacific, net revenues increased due to volume growth and higher pricing in China and Southeast Asia, partially offset by volume declines in Australia and New Zealand.

Segment operating income increased $16 million (4.0%), due primarily to higher pricing, net of unfavorable costs, favorable volume/mix (including the 53rd week in 2005) and favorable currency partially offset by higher marketing, administration and research costs, higher Restructuring Program costs, higher fixed manufacturing costs and an asset impairment charge related to biscuits assets in Egypt.

Critical Accounting Policies

Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements includes a summary of the significant accounting policies we used to prepare our consolidated financial statements. We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which require us to make certain elections as to our accounting policy, estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. Significant accounting policy elections, estimates and assumptions include, among others, pension and benefit plan assumptions, lives and valuation assumptions of goodwill and intangible assets, marketing programs and income taxes. Actual results could differ from those estimates.

We have discussed the selection and disclosure of our critical accounting policies and estimates with our Audit Committee. The following is a review of the more significant assumptions and estimates, as well as the accounting policies we used to prepare our consolidated financial statements.

 

32


Principles of Consolidation:

The consolidated financial statements include Kraft, as well as our wholly-owned and majority-owned subsidiaries. Our domestic operating subsidiaries report year-end results as of the Saturday closest to the end of each year, and our international operating subsidiaries generally report year-end results two weeks prior to the Saturday closest to the end of each year. This resulted in 53 weeks of operating results in our consolidated statement of earnings for the year ended December 31, 2005, versus 52 weeks for the years ended December 31, 2007 and 2006. The results of operations from our newly acquired global biscuit business of Groupe Danone S.A. will be reported on a one month lag. We account for investments in which we exercise significant influence (20% - 50% ownership interest) under the equity method of accounting. We account for investments in which we have an ownership interest of less than 20%, and do not exercise significant influence by the cost method of accounting. All intercompany transactions were eliminated. Transactions between Kraft and Altria are included in the consolidated financial statements.

Use of Estimates:

We prepare our financial statements in accordance with U.S. GAAP, which requires us to make estimates and assumptions that affect a number of amounts in our financial statements. These amounts include, among others, employee benefit costs and income taxes. We base our estimates on historical experience and other assumptions that we believe are reasonable. If actual amounts differ from estimates, we include the revisions in our consolidated results of operations in the period the actual amounts become known. Historically, the aggregate differences, if any, between our estimates and actual amounts in any year have not had a significant impact on our consolidated financial statements.

Inventories:

Inventories are stated at the lower of cost or market. The last-in, first-out (“LIFO”) method is used to cost a majority of domestic inventories. The cost of other inventories is principally determined by the average cost method. We used the LIFO method to determine the cost of 37% of inventories at December 31, 2007 and 41% of inventories at December 31, 2006. The stated LIFO amounts of inventories were $142 million lower at December 31, 2007 and $70 million higher at December 31, 2006 than the current cost of inventories. We also record inventory allowances for overstocked and obsolete inventories due to ingredient and packaging changes.

Long-Lived Assets:

We review long-lived assets, including amortizable intangible assets, for impairment when conditions exist that indicate the carrying amount of the assets may not be fully recoverable. We perform undiscounted operating cash flow analyses to determine if an impairment exists. When testing assets held for use for impairment, we group assets and liabilities at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, the loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal. During 2006, we recorded non-cash asset impairment charges of $245 million related to our Tassimo hot beverage system long-lived assets. The charges are included in asset impairment and exit costs in the consolidated statement of earnings.

Goodwill and Intangible assets:

SFAS No. 142, Goodwill and Other Intangible Assets, (“SFAS No. 142”) requires us to test goodwill and non-amortizable intangible assets at least annually for impairment. To test goodwill, we compare the fair value of each reporting unit with the carrying value of the reporting unit. If the carrying value exceeds the fair value, goodwill is considered impaired. The impairment loss is measured as the difference between the carrying value and implied fair value of goodwill, which is determined using discounted cash flows. To test non-amortizable intangible assets for impairment, we compare the fair value of the intangible asset with its carrying value. If the carrying value exceeds fair value, the intangible asset is considered impaired and is reduced to fair value. Definite lived intangible assets are amortized over their estimated useful lives.

Since our adoption of SFAS No. 142, we have completed our annual impairment review of goodwill and non-amortizable intangible assets as of January 1. During the first quarter of 2007, we completed our annual review of goodwill and non-amortizable intangible assets and found no impairments. Effective October 1, 2007, we adopted a new accounting policy to perform our annual impairment review of goodwill and non-amortizable intangible assets as of October 1 instead of January 1 of each year. The change in our testing date was made to align it with the revised timing of our annual strategic planning process implemented in 2007. As a result, we performed our annual impairment tests again as of October 1, 2007 and found no impairments. During the first quarter of 2006, we completed our annual review of goodwill and intangible assets and recorded a $24 million non-cash charge for impairment of biscuits assets in Egypt and hot cereal assets in the U.S. The charge is included

 

33


in asset impairment and exit costs in the consolidated statement of earnings. During the first quarter of 2005, we completed our annual review of goodwill and intangible assets. No impairments resulted from this review.

During the forth quarter of 2007, we acquired goodwill of $5,239 million and intangible assets of $2,196 million as part of the Danone Biscuit acquisition. These amounts represent the preliminary allocation of purchase price and are subject to revision when appraisals are finalized, which will occur during 2008. The application of FAS No. 141, Business Combinations, requires a number of significant judgments including the valuation of the cost of the acquisition and the assignment of such costs based on the estimated fair values of asses acquired and liabilities assumed.

Insurance & Self-Insurance:

We use a combination of insurance and self-insurance for a number of risks, including workers’ compensation, general liability, automobile liability, product liability and our obligation for employee healthcare benefits. Liabilities associated with the risks are estimated by considering historical claims experience and other actuarial assumptions.

Revenue Recognition:

We recognize revenues when title and risk of loss pass to customers, which occurs upon shipment or delivery of goods. Revenues are recorded net of consumer incentives and trade promotions and include all shipping and handling charges billed to customers. Kraft’s shipping and handling costs are classified as part of cost of sales. We also record provisions and allowances for estimated sales returns and bad debts in our consolidated financial statements. The amounts recorded for these provisions and related allowances are not significant to our financial statements.

Marketing costs:

We promote our products with advertising, consumer incentives and trade promotions. These programs include, but are not limited to, discounts, coupons, rebates, in-store display incentives and volume-based incentives. We expense advertising costs either in the period the advertising first takes place or as incurred. Consumer incentive and trade promotion activities are recorded as a reduction of revenues based on amounts estimated as being due to customers and consumers at the end of a period. We base these estimates principally on historical utilization and redemption rates. For interim reporting purposes, advertising and consumer incentive expenses are charged to operations as a percentage of volume, based on estimated volume and related expense for the full year. We do not defer costs on our year-end consolidated balance sheet and all marketing costs are recorded as an expense in the year incurred.

Environmental Costs:

We are subject to laws and regulations relating to the protection of the environment. We accrue for environmental remediation obligations on an undiscounted basis when amounts are probable and can be reasonably estimated. The accruals are adjusted as new information develops or circumstances change. Recoveries of environmental remediation costs from third parties are recorded as assets when their receipt is deemed probable. As of December 31, 2007, our subsidiaries were involved in 70 active Superfund and other similar actions in the U.S. related to current operations and certain former or divested operations for which we retain liability.

Based on information currently available, we believe that the ultimate resolution of existing environmental remediation actions and our compliance in general with environmental laws and regulations will not have a material effect on our financial results. However, we cannot quantify with certainty the potential impact of future compliance efforts and environmental remediation actions.

Income Taxes:

We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Prior to the Distribution, we were included in Altria’s consolidated federal income tax return. We generally computed income taxes on a separate company basis; however some of our foreign tax credits, capital losses and other credits could not have been used on a separate company basis. To the extent that Altria used our foreign tax credits and other tax benefits in its consolidated federal income tax return, we recognized the benefit in the calculation of our provision for income taxes. This benefit was approximately $270 million in 2007 (both through the date of Distribution as well as post-Distribution carryback claims to pre-Distribution periods), $195 million in 2006 and $225 in 2005. We made payments to, or were reimbursed by, Altria for the tax effects resulting from being included in Altria’s tax return. As of March 31, 2007, we are no longer a member of the Altria consolidated tax return group and will file our own federal consolidated income tax return.

 

34


In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for the Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). We adopted the provisions of FIN 48 effective January 1, 2007. FIN 48 clarifies when tax benefits should be recorded in the financial statements and provides measurement criteria for valuing such benefits. In order for us to recognize benefits, our tax position must be more likely than not to be sustained upon audit. The amount we recognize is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Before the implementation of FIN 48, we established additional provisions for certain positions that were likely to be challenged even though we believe that those existing tax positions were fully supportable. The adoption of FIN 48 resulted in an increase to shareholders’ equity as of January 1, 2007 of $213 million.

We recognize deferred tax assets for deductible temporary differences, operating loss carryforwards and tax credit carryforwards. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion, or all, of the deferred tax assets will not be realized.

Employee Benefit Plans:

As discussed in Note 9, Benefit Plans, to the consolidated financial statements, we provide a range of benefits to our employees and retired employees. These include pension plans, postretirement health care benefits and postemployment benefits, consisting primarily of severance. We record amounts relating to these plans based on calculations specified by U.S. GAAP. These calculations require the use of various actuarial assumptions, such as discount rates, assumed rates of return on plan assets, compensation increases, turnover rates and health care cost trend rates. We review our actuarial assumptions on an annual basis and make modifications to the assumptions based on current rates and trends when appropriate. As permitted by U.S. GAAP, we generally amortize any effect of the modifications over future periods. We believe that the assumptions used in recording our plan obligations are reasonable based on our experience and advice from our actuaries. Refer to Note 9 to the consolidated financial statements for a discussion of the assumptions used.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS No. 158”). SFAS No. 158 requires us to recognize the funded status of our defined benefit pension and other postretirement plans on the consolidated balance sheet. Subsequent changes in funded status that are not recognized as a component of net periodic benefit cost are recognized as a component of other comprehensive income. We prospectively adopted the recognition and related disclosure provisions of SFAS No. 158 on December 31, 2006. The adoption resulted in a decrease to total assets of $2,286 million, a decrease to total liabilities of $235 million and a decrease to shareholders’ equity of $2,051 million.

SFAS No. 158 also requires us to measure plan assets and benefit obligations as of the balance sheet date beginning in 2008. We currently measure our non-U.S. pension plans (other than Canadian pension plans) at September 30 of each year. We expect to adopt the measurement date provision of SFAS No. 158 and measure these plans as of our operating subsidiaries’ year-end close date, beginning in 2008. We are presently evaluating the impact of the measurement date change, which is not expected to be significant.

During the years ended December 31, 2007, 2006 and 2005, we recorded the following amounts in the consolidated statements of earnings for employee benefit plans:

 

         2007    2006    2005      
         (in millions)      
 

U.S. pension plan cost

   $      212    $      289    $      256                   
 

Non - U.S. pension plan cost

     123      155      140    
 

Postretirement health care cost

     260      271      253    
 

Postemployment benefit plan cost

     140      237      139    
 

Employee savings plan cost

     83      84      94    
                          
 

Net expense for employee benefit plans

   $ 818    $  1,036    $ 882    
                          

The 2007 net expense for employee benefit plans of $818 million decreased by $218 million over the 2006 amount. The cost decrease primarily relates to lower U.S. pension plan costs, including lower amortization of the net loss from experience differences, and lower postemployment benefit plan costs related to the Restructuring Program. The 2006 net expense for employee benefit plans of $1,036 million increased by $154 million over the 2005 amount. This cost increase primarily related

 

35


to higher postemployment benefit plan costs related to the Restructuring Program, as well as higher amortization of the net loss from experience differences in our U.S. and non-U.S. pension plan costs and postretirement health care costs.

At December 31, 2007, our health care cost trend rate assumption decreased from 8.00% to 7.50% for our U.S. postretirement plans and increased from 8.50% to 9.00% for our Canadian postretirement plans. We updated these rates based upon our expectation for health care trend rates going forward. We anticipate that our health care cost trend rate assumption will be 5.00% for U.S. plans and 6.00% for Canadian plans by 2013. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects as of December 31, 2007:

 

         One-Percentage-Point      
         Increase      Decrease      
 

Effect on total of service and interest cost

   13.3 %    (10.9 %)                  
 

Effect on postretirement benefit obligation

   10.8 %    (9.1 %)  

At December 31, 2007, our discount rate assumption increased from 5.90% to 6.10% for our U.S. postretirement plans, and increased from 5.90% to 6.30% for our U.S. pension plans. We model our discount rates using a portfolio of high quality, fixed-income debt instruments with durations that match the expected future cash flows of the benefit obligations. Changes in our discount rates are primarily the result of changes in bond yields year-over-year. Our expected rate of return on plan assets remained unchanged at 8.0%. We presently anticipate that assumption changes, coupled with the amortization of deferred gains and losses will result in a decrease in 2008 pre-tax U.S. and non-U.S. pension and postretirement expense. While we do not presently anticipate further changes in our 2008 assumptions, as a sensitivity measure, a fifty-basis point decline in our discount rate would increase our U.S. pension and postretirement expense by approximately $80 million, and a fifty-basis point increase in our discount rate would decrease our U.S. pension and postretirement expense by approximately $75 million. Similarly, a fifty-basis point decrease / (increase) in the expected rate of return on plan assets would increase / (decrease) our U.S. pension expense by approximately $33 million.

Transactions with Altria Group, Inc.:

On March 30, 2007, we entered into a post-spin Transition Services Agreement with Altria’s subsidiary, Altria Corporate Services, Inc. (“ALCS”). Under the agreement, ALCS was providing information technology services to Kraft during the EDS transition. Billings for these post-spin services were $10 million from April 2007 to December 31, 2007. Before the Distribution, ALCS provided pre-spin administrative services to us under a separate Corporate Services agreement that expired on March 30, 2007. These services included planning, legal, treasury, auditing, insurance, human resources, office of the secretary, corporate affairs, information technology, aviation and tax services. Billings for these pre-spin services, which were based on the cost to ALCS to provide such services and a 5% management fee based on wages and benefits, were $19 million for the quarter ended March 31, 2007, $178 million for the year ended December 31, 2006 and $237 million for the year ended December 31, 2005. We performed at a similar cost various functions in 2007 and 2006 that previously had been provided by ALCS, resulting in lower expense in 2007 and 2006. As of January 1, 2008, ALCS no longer provides services to Kraft.

On March 30, 2007, we also entered into Employee Matters and Tax Sharing Agreements with Altria. The Employee Matters Agreement sets out each company’s obligations for employee transfers, equity compensation and other employee benefits matters for individuals moving, or who previously moved between companies. The Tax Sharing Agreement identifies Altria’s and Kraft’s rights, responsibilities and obligations with respect to our income taxes following the Distribution. It also places certain restrictions on us, including a 2-year limit on share repurchases of no more than 20% of our Common Stock outstanding at the time of the Distribution.

At the Distribution, we had short-term amounts payable to Altria and affiliates of $449 million, which included $364 million of accrued dividends. We paid these amounts in April 2007. At December 31, 2007 we had no short-term amounts payable to Altria and affiliates for transition services. At December 31, 2006 we had short-term amounts payable to Altria and affiliates of $607 million. The fair values of our short-term amounts due to Altria and affiliates approximated carrying amounts.

In the first quarter 2007, we repurchased 1.4 million shares of our Common Stock from Altria at a cost of $46.5 million. We paid $32.085 per share, which was the average of the high and the low price of Kraft Common Stock as reported on the NYSE on March 1, 2007. This repurchase was in accordance with the Distribution agreement.

 

36


Also, see Note 5, Income Taxes, for information on how the closure of an IRS review of Altria’s consolidated federal income tax return in 2006 impacted us.

Financial Instruments:

As Kraft operates globally, we use certain financial instruments to manage our foreign currency exchange rate and commodity price risks. We monitor and manage these exposures as part of our overall risk-management program. Our risk management program focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on our operating results. We maintain foreign currency and commodity price risk management strategies that seek to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates and commodity prices, principally through the use of derivative instruments.

Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. We formally document the nature of and relationships between the hedging instruments and hedged items, as well as our risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction will occur. If we deem it probable that the forecasted transaction will not occur, we recognize the gain or loss in earnings currently.

By using derivatives to hedge exposures to changes in exchange rates and commodity prices, Kraft has exposure on these derivatives to credit and market risk. We are exposed to credit risk that the counterparty might fail to fulfill its performance obligations under the terms of the derivative contract. We minimize our credit risk by entering into transactions with high-quality counterparties with investment grade credit ratings, limiting the amount of exposure we have with each counterparty and monitoring the financial condition of our counterparties. We also maintain a policy of requiring that all significant, non-exchange traded derivative contracts be governed by an International Swaps and Derivatives Association master agreement. Market risk is the risk that the value of the financial instrument might be adversely affected by a change in foreign currency exchange rates, commodity prices, or interest rates. We manage market risk by incorporating monitoring parameters within our risk management strategy that limit the types of derivative instruments and derivative strategies, and the degree of market risk that may be undertaken by the use of derivative instruments.

We record derivative financial instruments at fair value in our consolidated balance sheets as either current assets or current liabilities. Changes in the fair value of derivatives are recorded each period either in accumulated other comprehensive earnings / (losses) or in earnings, depending on whether a derivative is designated and effective as part of a hedge transaction and, if it is, the type of hedge transaction. Gains and losses on derivative instruments reported in accumulated other comprehensive earnings / (losses) are reclassified to the consolidated statement of earnings in the periods in which operating results are affected by the hedged item. Cash flows from hedging instruments are classified in the same manner as the affected hedged item in the consolidated statements of cash flows.

Commodity Trends

We are major purchasers of dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and sugar and other sweeteners. We also use significant quantities of glass, plastic and cardboard to package our products, and natural gas for our factories and warehouses. We continuously monitor worldwide supply and cost trends of these commodities so we can act quickly to obtain ingredients and packaging needed for production. We purchase a substantial portion of our dairy raw material requirements, including milk and cheese, from independent third parties such as agricultural cooperatives and independent processors. The prices for milk and other dairy product purchases are substantially influenced by market supply and demand, as well as by government programs. Dairy commodity costs on average were $750 million higher in 2007 than in 2006.

The most significant cost item in coffee products is green coffee beans, which are purchased on world markets. Green coffee bean prices are affected by the quality and availability of supply, trade agreements among producing and consuming nations, the unilateral policies of the producing nations, changes in the value of the U.S. dollar in relation to certain other currencies and consumer demand for coffee products. In 2007, coffee bean costs on average were higher than in 2006. A significant cost item in chocolate confectionery products is cocoa, which is purchased on world markets, and the price of which is affected by the quality and availability of supply and changes in the value of the British pound sterling and the U.S. dollar relative to certain other currencies. In 2007, cocoa bean and cocoa butter costs on average were higher than in 2006. Significant cost items in our

 

37


biscuit, cereal, and grocery products are grains or wheat, corn, and soybean oil. Grain costs have experienced significant cost increases as a result of burgeoning global demand for food, livestock feed and biofuels such as ethanol and biodiesel. In 2007, grain costs on average were higher than in 2006.

During 2007, our aggregate commodity costs rose significantly as a result of higher dairy, coffee, cocoa, wheat, meat products, soybean oil and packaging costs, partially offset by lower nut costs. For 2007, our commodity costs were approximately $1,250 million higher than 2006, following an increase of approximately $275 million in 2006 compared to 2005. We expect the higher cost environment to continue, particularly for dairy, grains, energy and packaging.

Liquidity

We believe that our cash from operations, our existing $4.5 billion credit facility, and our authorized long-term financing will provide sufficient liquidity to meet our working capital needs (including the cash requirements of the Restructuring Program), planned capital expenditures, future contractual obligations, authorized share repurchases, and payment of our anticipated quarterly dividends.

Net Cash Provided by Operating Activities:

Operating activities provided net cash of $3.6 billion in 2007, $3.7 billion in 2006 and $3.5 billion in 2005. Operating cash flows decreased in 2007 from 2006 primarily due to the $405 million tax reimbursement from Altria in 2006 related to the closure of a tax audit and increased marketing administration and research costs. This decrease in operating cash flows was partially offset by lower working capital costs of $225 million primarily due to lower income tax payments and the $305 million tax transfer from Altria for the federal tax contingencies held by them, less the impact of federal reserves reversed due to the adoption of FIN 48. The transfer from Altria is reflected within other in our consolidated statements of cash flows.

The increase in 2006 operating cash flows from 2005 is due primarily to the previously discussed tax reimbursement from Altria in 2006 related to the closure of a tax audit and higher earnings, partially offset by a decrease in amounts due to Altria and higher pension contributions.

Net Cash Provided by (Used in) Investing Activities:

One element of our growth strategy is to strengthen our brand portfolios and/or expand our geographic reach through disciplined programs of selective acquisitions and divestitures. We are constantly reviewing potential acquisition candidates and from time to time sell businesses to accelerate the shift in our portfolio toward businesses - whether global, regional or local - that offer us a sustainable competitive advantage. The impact of future acquisitions or divestitures could have a material impact on our cash flows.

Net cash used in investing activities was $8.4 billion during 2007 and $116 million during 2006, as compared with net cash provided by investing activities of $525 million in 2005. The increase in cash used in investing activities in 2007 primarily related to the Danone Biscuit acquisition and lower proceeds from divestitures. On November 30, 2007, we acquired the global biscuit business of Groupe Danone S.A. for approximately €5.1 billion (approximately $7.6 billion) in cash subject to purchase price adjustments.

During 2007, we received proceeds of $216 million from the sales of our flavored water and juice brand assets and related trademarks, our sugar confectionery assets in Romania and related trademarks and our hot cereal assets and trademarks. During 2006, we received proceeds of $946 million from the sales of our rice brand and assets, pet snacks brand and assets, industrial coconut assets, certain Canadian assets, a small U.S. biscuit brand and a U.S. coffee plant. During 2005, we received proceeds of $1,668 million from the sales of our sugar confectionery business, fruit snacks assets, U.K. desserts assets, U.S. yogurt assets, a small operation in Colombia, a small equity investment in Turkey and a minor trademark in Mexico.

Capital expenditures, which were funded by operating activities, were $1.2 billion in each of the last three years. The 2007 capital expenditures were primarily to modernize manufacturing facilities, implement the Restructuring Program, and support new product and productivity initiatives. We expect 2008 capital expenditures to be in line with 2007 expenditures, including capital expenditures required for the Restructuring Program and systems investments. We expect to fund these expenditures from operations.

Net Cash Used in Financing Activities:

During 2007, we received $5.1 billion net cash in financing activities, compared with $3.7 billion that we used during 2006. The increase in net cash provided by financing activities is due primarily to the $3.5 billion and $3.0 billion long-term debt offerings

 

38


and net outstanding borrowings of $5.5 billion under the bridge facility used to fund our Danone Biscuit acquisition, partially offset by $3.7 billion in Common Stock share repurchases and a $1.5 billion repayment of long-term debt that matured in 2007.

During 2006, we used $3.7 billion net cash in financing activities, compared with $4.0 billion that we used during 2005. The decrease in net cash used in 2006 was due primarily to a decrease in net debt repayments, partially offset by an increase in our Common Stock share repurchases and dividend payments.

Borrowing Arrangements:

On October 12, 2007, we entered into a 364-day bridge facility agreement for €5.3 billion for our pending acquisition of Danone Biscuit (“Danone Biscuit Bridge Facility”). Upon closing of the transaction, we borrowed €5.1 billion (approximately $7.5 billion) under this facility to finance the acquisition. We intend to repay our outstanding borrowings under this facility with proceeds from the issuance of investment grade bonds or other securities. According to the credit agreement, aggregate net cash proceeds in excess of $1.0 billion from debt offerings having a maturity of greater than one year are required to be repaid. As such, we repaid approximately €1.3 billion ($2.0 billion) of the bridge facility with the proceeds from our December 2007 debt issuance. Additionally, proceeds from equity offerings are required to be repaid under the facility, and drawings under this facility may be reduced by the aggregate proceeds in excess of $1.0 billion from certain divestitures of assets. This facility replaced a commitment letter we entered into upon the announcement of the Danone Biscuit acquisition.

On May 24, 2007, we entered into a $1.5 billion, 364-day revolving credit agreement. In accordance with the terms of that agreement, it was terminated upon our issuance of the $3.5 billion of senior unsecured notes in August 2007.

We maintain a revolving credit facility that we have historically used for general corporate purposes and to support our commercial paper issuances. The $4.5 billion, multi-year revolving credit facility expires in April 2010. No amounts were drawn on this facility at December 31, 2007.

We must maintain a net worth of at least $20.0 billion under the terms of our revolving credit facility. At December 31, 2007, our net worth was $27.3 billion. We expect to continue to meet this covenant. The revolving credit facility has no other financial covenants, credit rating triggers or provisions that could require us to post collateral as security.

In addition to the above, some of our international subsidiaries maintain primarily uncommitted credit lines to meet short-term working capital needs. Collectively, these credit lines amounted to $1.5 billion at December 31, 2007. Borrowings on these lines amounted to $250 million at December 31, 2007 and $465 million at December 31, 2006, which included $282 million of outstanding short-term debt related to our United Biscuits acquisition discussed in Note 11, Acquisitions.

Debt:

Our total debt was $21.0 billion at December 31, 2007 and $10.8 billion at December 31, 2006. Our total debt balance at December 31, 2006, included amounts due to Altria and affiliates. Our debt-to-capitalization ratio was 0.43 at December 31, 2007 and 0.27 at December 31, 2006.

In August 2007, we issued $3.5 billion of senior unsecured notes, which was the remainder of the capacity under our existing Form S-3 shelf registration statement on file with the SEC. We used the net proceeds from the offering (approximately $3,462 million) for general corporate purposes, including the repayment of outstanding commercial paper.

In December 2007, we filed an automatic shelf registration on Form S-3 with the SEC. As a well-known seasoned issuer, we are able to register new debt securities in amounts authorized by our Board of Directors through December 2010. Our Board of Directors authorized $5.0 billion in long-term financing, which was in addition to the €5.3 billion authorized for the Danone Biscuit acquisition.

In December 2007, we issued $3.0 billion of senior unsecured notes under the shelf registration. We used the net proceeds from the offering (approximately $2,966 million) for general corporate purposes, including the repayment of outstanding commercial paper and a portion of our Danone Biscuit Bridge Facility. Refer to Note 4, Debt and Borrowing Arrangements, for further details of these debt offerings.

We refinance long-term and short-term debt from time to time. The nature and amount of our long-term and short-term debt and the proportionate amount of each varies as a result of future business requirements, market conditions and other factors. At December 31, 2007, we had approximately $9.5 billion remaining in long-term financing authority from our Board of Directors.

 

39


Approximately $5.5 billion (approximately €3.8 billion) was earmarked for the refinancing of our Danone Biscuit Bridge Facility.

At December 31, 2007 we had no short-term amounts payable to Altria and its affiliates for transition services. At December 31, 2006 we had short-term amounts payable to Altria and affiliates of $607 million, which included $364 million of accrued dividends. Prior to the Distribution, the amounts payable to Altria generally included accrued dividends, taxes and service fees.

Credit Ratings:

At December 31, 2007, our debt ratings by major credit rating agencies were:

 

         Short - term    Long - term                   
  Moody’s    P-2    Baa2           
  Standard & Poor’s    A-2    BBB+           
  Fitch    F2    BBB           

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

We have no off-balance sheet arrangements other than the guarantees and contractual obligations that are discussed below.

Guarantees:

As discussed in Note 15, Commitments and Contingencies, we have third-party guarantees because of our acquisition, divestiture and construction activities. As part of those transactions, we guarantee that third parties will make contractual payments or achieve performance measures. At December 31, 2007, the maximum potential payments under our third-party guarantees were $32 million, of which $8 million have no specified expiration dates. Substantially all of the remainder expire at various times through 2016. The carrying amounts of these guarantees were $25 million on our consolidated balance sheet at December 31, 2007.

In addition, at December 31, 2007, we were contingently liable for $180 million of guarantees related to our own performance. These include surety bonds related to dairy commodity purchases and guarantees related to the payment of custom duties and taxes, and letters of credit.

Guarantees do not have, and we do not expect them to have a significant impact on our liquidity.

Aggregate Contractual Obligations:

The following table summarizes our contractual obligations at December 31, 2007:

 

         Payments Due    
         Total    2008    2009-10    2011-12    2013 and
Thereafter
   
         (in millions)    
 

Long - term debt (1)

   $ 13,657    $ 722    $ 1,264    $ 3,706    $ 7,965  
 

Interest expense (2)

     8,916      814      1,534      1,275      5,293  
 

Operating leases (3)

     860      256      329      193      82  
 

Purchase obligations (4):

                
 

Inventory and production
costs

     4,316      3,423      621      272      -  
 

Other

     1,037      772      162      101      2  
                                      
       5,353      4,195      783      373      2  
 

Other long - term liabilities (5)

     2,336      221      496      456      1,163  
                                      
     $ 31,122    $ 6,208    $ 4,406    $ 6,003    $ 14,505  
                                      

 

  (1) Amounts represent the expected cash payments of our long-term debt and do not include unamortized bond premiums or discounts.
  (2) Amounts represent the expected cash payments of our interest expense on our long-term debt. Interest calculated on our variable rate debt was forecasted using a LIBOR rate forward curve analysis as of December 31, 2007. An insignificant amount of interest expense was excluded from the table for a portion of our foreign debt due to the complexities involved in forecasting expected interest payments.

 

40


  (3) Operating leases represent the minimum rental commitments under non-cancelable operating leases. We have no significant capital lease obligations.
  (4) Purchase obligations for inventory and production costs (such as raw materials, indirect materials and supplies, packaging, co-manufacturing arrangements, storage and distribution) are commitments for projected needs to be utilized in the normal course of business. Other purchase obligations include commitments for marketing, advertising, capital expenditures, information technology and professional services. Arrangements are considered purchase obligations if a contract specifies all significant terms, including fixed or minimum quantities to be purchased, a pricing structure and approximate timing of the transaction. Most arrangements are cancelable without a significant penalty, and with short notice (usually 30 days). Any amounts reflected on the consolidated balance sheet as accounts payable and accrued liabilities are excluded from the table above.
  (5) Other long-term liabilities primarily consist of postretirement health care costs of $2,280. The following long-term liabilities included on the consolidated balance sheet are excluded from the table above: accrued pension costs, income taxes, minority interest, insurance accruals and other accruals. We are unable to estimate the timing of the payments (or contributions in the case of accrued pension costs) for these items. Currently, we anticipate making U.S. pension contributions of approximately $15 million in 2008 and non-U.S. pension contributions of approximately $160 million in 2008, based on current tax law. As of December 31, 2007, our total liability for income taxes, including uncertain tax positions and associated accrued interest and penalties, was $1,121 million. We expect to pay approximately $100 million in the next twelve months. While years 2000 through 2003 are currently under examination by the IRS, we are not able to reasonably estimate the timing of future cash flows beyond 12 months due to uncertainties in the timing of this and other tax audit outcomes.

Equity and Dividends

Stock Repurchases:

Our Board of Directors authorized the following Common Stock repurchase programs. We are not obligated to repurchase any of our Common Stock and may suspend any program at our discretion. The total repurchases under these programs were 110.1 million shares for $3,640 million in 2007, 38.7 million shares for $1,250 million in 2006, and 39.2 million shares for $1,200 million in 2005. We made these repurchases of our Common Stock in open market transactions.

 

Share Repurchase Program

authorized by the Board of Directors

  $5.0 billion   $2.0 billion   $1.5 billion

Authorized/Completed period for repurchase

  April 2007 -

March 2009

  March 2006 -

March 2007

  December 2004 -

March 2006

Aggregate cost of shares repurchased in 2007
(millions of shares)

  $3.5 billion

(105.6 shares)

  $140 million

(4.5 shares)

 

Aggregate cost of shares repurchased in 2006
(millions of shares)

    $1.0 billion

(30.2 shares)

  $250 million

(8.5 shares)

Aggregate cost of shares repurchased in 2005
(millions of shares)

      $1.2 billion

(39.2 shares)

Aggregate cost of shares repurchased life-to-date under program (millions of shares)

  $3.5 billion

(105.6 shares)

  $1.1 billion

(34.7 shares)

  $1.5 billion

(49.1 shares)

Additionally, in March 2007, we repurchased 1.4 million shares of our Common Stock from Altria at a cost of $46.5 million. We paid $32.085 per share, which was the average of the high and the low price of Kraft Common Stock as reported on the NYSE on March 1, 2007. This repurchase was in accordance with the Distribution agreement.

As of December 31 2007, we had $1.5 billion left under our $5.0 billion share repurchase program and we expect to complete the program before the authorization expires in March 2009.

Stock Based Compensation:

At the Distribution, Altria stock awards were modified through the issuance of Kraft stock awards, and accordingly the Altria stock awards were split into two instruments. Holders of Altria stock options received: 1) a new Kraft option to acquire shares of Kraft Common Stock; and 2) an adjusted Altria stock option for the same number of shares of Altria common stock

 

41


previously held, but with a proportionally reduced exercise price. For each employee stock option outstanding, the aggregate intrinsic value immediately after the Distribution was not greater than the aggregate intrinsic value immediately prior to the Distribution. Holders of Altria restricted stock or stock rights awarded before January 31, 2007, retained their existing awards and received restricted stock or stock rights in Kraft Common Stock. Recipients of Altria restricted stock or stock rights awarded on or after January 31, 2007, did not receive Kraft restricted stock or stock rights because Altria had announced the Distribution at that time. We reimbursed Altria $179 million for net settlement of the employee stock awards as detailed below. We determined the fair value of the stock options using the Black-Scholes option valuation model; and adjusted the fair value of the restricted stock and stock rights by the value of projected forfeitures.

In April 2007, we paid the following to Altria (in millions):

 

 

Kraft stock options received by Altria employees

      $             240    
 

Altria stock options received by Kraft employees

        (440 )  
 

Kraft stock awards received by holders of Altria stock awards

        33    
 

Altria stock awards received by holders of Kraft stock awards

        (12 )  
               
 

Net payment to Altria

      $ (179 )  
               

Based upon the number of Altria stock awards outstanding at Distribution, we granted stock options for 24.2 million shares of Common Stock at a weighted-average price of $15.75. The options expire between 2007 and 2012. In addition, we issued 3.0 million shares of restricted stock and stock rights. The market value per restricted share or right was $31.66 on the date of grant. Restrictions on the majority of these restricted stock and stock rights lapse in either the first quarter of 2008 or 2009.

Our Board of Directors approved a stock option grant to our Chief Executive Officer on May 3, 2007, to recognize her election as our Chairman. She received 300,000 stock options under the 2005 Performance Incentive Plan, which vest under varying market and service conditions and expire ten years after the grant date.

In January 2007, we issued 5.2 million shares of restricted stock and stock rights to eligible U.S. and non-U.S. employees as part of our annual incentive program. Restrictions on these shares and rights lapse in the first quarter of 2010. The market value per restricted share or right was $34.655 on the date of grant. Additionally, we issued 1.0 million off-cycle shares of restricted stock and stock rights during 2007. The weighted-average market value per restricted share or right was $34.085 on the date of grant. The total number of restricted shares and rights issued in 2007 was 9.2 million, including those issued as a result of the Distribution.

In 2006, we issued approximately 6.9 million shares of restricted stock and stock rights to eligible U.S. and non-U.S. employees. Restrictions on most of these shares and rights lapse in the first quarter of 2009. The market value per restricted share or right was $29.16 on the date of grant.

Effective January 1, 2006, we adopted the provisions of SFAS No. 123 (Revised 2004), Share-Based Payment, using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service periods for awards expected to vest. The fair value of restricted stock and rights to receive shares of stock is determined based on the number of shares granted and the market value at date of grant. The fair value of stock options is determined using a modified Black-Scholes methodology. The impact of adoption was not material. At December 31, 2007, the number of shares to be issued upon exercise of outstanding stock options and vesting of non-U.S. rights to receive equivalent shares was 37.5 million or 2.4% of total shares outstanding.

Dividends:

We paid dividends of $1,638 million in 2007 and $1,562 million in 2006. The 4.9% increase reflects a higher dividend rate in 2007, partially offset by a lower number of shares outstanding because of share repurchases. During the third quarter of 2007, our Board of Directors approved an 8.0% increase in the current quarterly dividend rate to $0.27 per share on our Common Stock. As a result, the present annualized dividend rate is $1.08 per common share. The declaration of dividends is subject to the discretion of our Board of Directors and depends on various factors, including our net earnings, financial condition, cash requirements, future prospects and other factors that our Board of Directors deems relevant to its analysis and decision-making.

 

42


2008 Outlook

We expect diluted EPS of at least $1.56 for 2008. Our guidance reflects $0.34 per diluted share in costs related to the Restructuring Program, up from $0.19 in 2007. Also reflected in our guidance, we expect an effective tax rate of 34.0% for 2008.

Guidance reflects our expectation for greater savings from our Restructuring Program. Total costs are expected to be $2.8 billion, down from our previous expectation of $3.0 billion. We also expect cumulative, annualized savings to reach $1.2 billion by the end of 2009. Our guidance reflects the inclusion of the Danone Biscuit business for 2008, but does not include the impact of our agreement to merge our Post Business with Ralcorp Holdings, Inc.

The factors described in Item 1A, Risk Factors, represent continuing risks to these forecasts.

New Accounting Standards

See Notes 1 and 9 to the consolidated financial statements for a discussion of new accounting standards.

Contingencies

See Note 15 to the consolidated financial statements and Part I Item 3. Legal Proceedings for a discussion of contingencies.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

As Kraft operates globally, we use certain financial instruments to manage our foreign currency exchange rate and commodity price risks. We monitor and manage these exposures as part of our overall risk-management program. Our risk management program focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on our operating results. We maintain foreign currency and commodity price risk management policies that principally use derivative instruments to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates and commodity prices. We occasionally use related futures to cross-hedge a commodity exposure, however we are not a party to leveraged derivatives and, by policy, do not use financial instruments for speculative purposes. Refer to Notes 1 and 14 to the consolidated financial statements for further details of our foreign currency and commodity price risk management policies and the types of derivative instruments we use to hedge those exposures.

Value at Risk:

We use a value at risk (“VAR”) computation to estimate: 1) the potential one-day loss in the fair value of our interest rate-sensitive financial instruments; and 2) the potential one-day loss in pre-tax earnings of our foreign currency and commodity price-sensitive derivative financial instruments. We included our debt; short-term investments; foreign currency forwards, swaps and options; and commodity futures, forwards and options in our VAR computation. Anticipated transactions, foreign currency trade payables and receivables, and net investments in foreign subsidiaries, which the abovementioned instruments are intended to hedge, were excluded from the computation.

We made the VAR estimates assuming normal market conditions, using a 95% confidence interval. We used a “variance/co-variance” model to determine the observed interrelationships between movements in interest rates and various currencies. These interrelationships were determined by observing interest rate and forward currency rate movements over the prior quarter for the calculation of VAR amounts at December 31, 2007 and 2006, and over each of the four prior quarters for the calculation of average VAR amounts during each year. The values of foreign currency and commodity options do not change on a one-to-one basis with the underlying currency or commodity, and were valued accordingly in the VAR computation.

 

43


The estimated potential one-day loss in fair value of our interest rate-sensitive instruments, primarily debt, under normal market conditions and the estimated potential one-day loss in pre-tax earnings from our foreign currency and commodity instruments under normal market conditions, as calculated in the VAR model, were (in millions):

 

    Pre-Tax Earnings Impact   Fair Value Impact
    At 12/31/07   Average   High   Low   At 12/31/07   Average   High   Low

Instruments sensitive to:

               

Interest rates

          $           94   $           49   $           94   $           23

Foreign currency rates

  $           17   $           22   $           28   $           17        

Commodity prices

    27     19     27     15        
    Pre-Tax Earnings Impact   Fair Value Impact
    At 12/31/06   Average   High   Low   At 12/31/06   Average   High   Low

Instruments sensitive to:

               

Interest rates

          $ 26   $ 28   $ 31   $ 26

Foreign currency rates

  $ 25   $ 27   $ 36   $ 23        

Commodity prices

    3     6     9     3        

This VAR computation is a risk analysis tool designed to statistically estimate the maximum probable daily loss from adverse movements in interest rates, foreign currency rates and commodity prices under normal market conditions. The computation does not represent actual losses in fair value or earnings to be incurred by Kraft, nor does it consider the effect of favorable changes in market rates. We cannot predict actual future movements in such market rates and do not present these VAR results to be indicative of future movements in such market rates or to be representative of any actual impact that future changes in market rates may have on our future financial results.

 

44


Item 8. Financial Statements and Supplementary Data.

Kraft Foods Inc. and Subsidiaries

Consolidated Statements of Earnings

for the years ended December 31,

(in millions of dollars, except per share data)

 

 

     2007      2006      2005  

Net revenues

   $ 37,241      $ 34,356      $ 34,113  

Cost of sales

     24,651        21,940        21,845  
                          

Gross profit

     12,590        12,416        12,268  

Marketing, administration and research costs

     7,809        7,254        7,138  

Asset impairment and exit costs

     452        1,002        479  

Gain on redemption of United Biscuits investment

     -        (251 )      -  

Gains on divestitures, net

     (15 )      (117 )      (108 )

Amortization of intangibles

     13        7        10  
                          

Operating income

     4,331        4,521        4,749  

Interest and other debt expense, net

     604        510        636  
                          

Earnings from continuing operations before income taxes

     3,727        4,011        4,113  

Provision for income taxes

     1,137        951        1,209  
                          

Earnings from continuing operations

     2,590        3,060        2,904  

Loss from discontinued operations, net of income taxes

     -        -        (272 )
                          

Net earnings

   $ 2,590      $ 3,060      $ 2,632  
                          

Per share data:

        

Basic earnings per share:

        

Continuing Operations

   $ 1.64      $ 1.86      $ 1.72  

Discontinued Operations

     -        -        (0.16 )
                          

Net Earnings

   $ 1.64      $ 1.86      $ 1.56  
                          

Diluted earnings per share:

        

Continuing Operations

   $ 1.62      $ 1.85      $ 1.72  

Discontinued Operations

     -        -        (0.17 )
                          

Net Earnings

   $ 1.62      $ 1.85      $ 1.55  
                          

Dividends declared

   $ 1.04      $ 0.96      $ 0.87  
                          

See notes to consolidated financial statements.

 

45


Kraft Foods Inc. and Subsidiaries

Consolidated Balance Sheets, at December 31,

(in millions of dollars)

 

     2007      2006  

ASSETS

     

Cash and cash equivalents

   $ 567      $ 239  

Receivables (less allowances of $94 in 2007 and $84 in 2006)

     5,197        3,869  

Inventories:

     

Raw materials

     1,605        1,389  

Finished product

     2,491        2,117  
                 

Total inventories

     4,096        3,506  

Deferred income taxes

     575        387  

Other current assets

     302        253  
                 

Total current assets

     10,737        8,254  

Property, plant and equipment, at cost:

     

Land and land improvements

     454        389  

Buildings and building equipment

     4,121        3,657  

Machinery and equipment

     13,750        12,164  

Construction in progress

     879        840  
                 
     19,204        17,050  

Less accumulated depreciation

     8,426        7,357  
                 

Property, plant and equipment, net

     10,778        9,693  

Goodwill

     31,193        25,553  

Intangible assets, net

     12,200        10,177  

Prepaid pension assets

     1,648        1,168  

Other assets

     1,437        729  
                 

TOTAL ASSETS

   $        67,993      $        55,574  
                 

LIABILITIES

     

Short-term borrowings

   $ 7,385      $ 1,715  

Current portion of long-term debt

     722        1,418  

Due to Altria Group, Inc. and affiliates

     -        607  

Accounts payable

     4,065        2,602  

Accrued liabilities:

     

Marketing

     1,833        1,626  

Employment costs

     913        750  

Dividends payable

     414        45  

Other

     1,654        1,559  

Income taxes

     100        151  
                 

Total current liabilities

     17,086        10,473  

Long-term debt

     12,902        7,081  

Deferred income taxes

     4,876        3,930  

Accrued pension costs

     810        1,022  

Accrued postretirement health care costs

     2,846        3,014  

Other liabilities

     2,178        1,499  
                 

TOTAL LIABILITIES

     40,698        27,019  

Contingencies (Note 15)

     

SHAREHOLDERS’ EQUITY

     

Class A common stock, no par value (1,735,000,000 shares issued in
2007 and 555,000,000 shares issued in 2006)

     -        -  

Class B common stock, no par value (1,180,000,000 shares issued
and outstanding in 2006)

     -        -  

Additional paid-in capital

     23,445        23,626  

Retained earnings

     12,209        11,128  

Accumulated other comprehensive losses

     (1,835 )      (3,069 )

Treasury stock, at cost

     (6,524 )      (3,130 )
                 

TOTAL SHAREHOLDERS’ EQUITY

     27,295        28,555  
                 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 67,993      $ 55,574  
                 

See notes to consolidated financial statements.

 

46


Kraft Foods Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity

(in millions of dollars, except per share data)

 

    Class
A and B
Common

Stock
  Additional
Paid-in

Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Losses
    Treasury
Stock
    Total
Shareholders’
Equity
 

Balances at January 1, 2005

  $                   -   $         23,762     $           8,304     $          (1,205 )   $             (950 )   $           29,911  

Comprehensive earnings:

           

Net earnings

    -     -       2,632       -       -       2,632  

Other comprehensive losses, net of income taxes

    -     -       -       (458 )     -       (458 )
                 

Total comprehensive earnings

              2,174  
                 

Exercise of stock options and issuance of other stock awards

    -     52       (12 )     -       118       158  

Cash dividends declared
($0.87 per share)

    -     -       (1,471 )     -       -       (1,471 )

Common Stock repurchased

    -     -       -       -       (1,200 )     (1,200 )

Other

    -     21       -       -       -       21  
                                             

Balances at December 31, 2005

  $ -   $ 23,835     $ 9,453     $ (1,663 )   $ (2,032 )   $ 29,593  

Comprehensive earnings:

           

Net earnings

    -     -       3,060       -       -       3,060  

Other comprehensive earnings, net of income taxes

    -     -       -       645       -       645  
                 

Total comprehensive earnings

              3,705  
                 

Initial adoption of FASB Statement No. 158, net of income taxes
(Note 9)

    -     -       -       (2,051 )     -       (2,051 )

Exercise of stock options and issuance of other stock awards

    -     (209 )     202       -       152       145  

Cash dividends declared
($0.96 per share)

    -     -       (1,587 )     -       -       (1,587 )

Common Stock repurchased

    -     -       -       -       (1,250 )     (1,250 )
                                             

Balances at December 31, 2006

  $ -   $ 23,626     $ 11,128     $ (3,069 )   $ (3,130 )   $ 28,555  

Comprehensive earnings:

           

Net earnings

    -     -       2,590       -       -       2,590  

Other comprehensive earnings, net of income taxes

    -     -       -       1,234       -       1,234  
                 

Total comprehensive earnings

              3,824  
                 

Initial adoption of FIN 48 (Note 1)

    -     -       213       -       -       213  

Exercise of stock options and issuance of other stock awards

    -     33       (79 )     -       293       247  

Net settlement of employee stock awards with Altria Group, Inc.
(Note 8)

    -     (179 )     -       -       -       (179 )

Cash dividends declared
($1.04 per share)

    -     -       (1,643 )     -       -       (1,643 )

Common Stock repurchased

    -     -       -       -       (3,687 )     (3,687 )

Other

    -     (35 )     -       -       -       (35 )
                                             

Balances at December 31, 2007

  $ -   $ 23,445     $ 12,209     $ (1,835 )   $ (6,524 )   $ 27,295  
                                             

See notes to consolidated financial statements.

 

47


Kraft Foods Inc. and Subsidiaries

Consolidated Statements of Cash Flows

for the years ended December 31,

(in millions of dollars)

 

     2007     2006     2005  

CASH PROVIDED BY / (USED IN) OPERATING ACTIVITIES

      

Net earnings