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Mondelez International, Inc. 10-K 2011
Form 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark one)   FORM 10-K  

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

For the fiscal year ended December 31, 2010

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   60093-2753
(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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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. x

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 30, 2010, was $49 billion. At January 31, 2011, there were 1,748,927,248 shares of the registrant’s Class A Common Stock outstanding.

Documents Incorporated by Reference

Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its annual meeting of shareholders to be held on May 24, 2011 are incorporated by reference into Part III hereof.

 

 

 


Kraft Foods Inc.

Table of Contents

 

                Page No.      
Part I -        
Item 1.      Business      1   
Item 1A.      Risk Factors      10   
Item 1B.      Unresolved Staff Comments      15   
Item 2.      Properties      15   
Item 3.      Legal Proceedings      16   
Part II -        
Item 5.     

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

     17   
Item 6.      Selected Financial Data      19   
Item 7.     

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

     20   
     Discussion and Analysis      21   
     Critical Accounting Policies      39   
     Commodity Trends      45   
     Liquidity      46   
    

Off-Balance Sheet Arrangements and Aggregate Contractual
Obligations

     48   
     Equity and Dividends      50   
Item 7A.      Quantitative and Qualitative Disclosures about Market Risk      53   
Item 8.      Financial Statements and Supplementary Data   
    

Consolidated Statements of Earnings for the years ended December 31,
2009, 2008 and 2007

     55   
     Consolidated Balance Sheets at December 31, 2009 and 2008      56   
    

Consolidated Statements of Equity for the years ended December 31,
2009, 2008 and 2007

     57   
    

Consolidated Statements of Cash Flows for the years ended
December 31, 2009, 2008 and 2007

     58   
     Notes to Consolidated Financial Statements      59   
Item 9.     

Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

     100   
Item 9A.      Controls and Procedures      100   
     Report of Management on Internal Control over Financial Reporting      101   
     Report of Independent Registered Public Accounting Firm      102   
Item 9B.      Other Information      103   
Part III -        
Item 10.      Directors, Executive Officers and Corporate Governance      103   
Item 11.      Executive Compensation      103   
Item 12.     

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

     103   
Item 13.     

Certain Relationships and Related Transactions, and Director
Independence

     103   
Item 14.      Principal Accountant Fees and Services      103   
Part IV -        
Item 15.      Exhibits and Financial Statement Schedules      104   
     Signatures      107   
    

Report of Independent Registered Public Accounting Firm
on Financial Statement Schedule

     S-1   
     Valuation and Qualifying Accounts      S-2   

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

 

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Forward-looking Statements

This report contains a number of forward-looking statements. Words, and variations of words, such as “expect,” “goals,” “plans,” “believe,” “continue,” “may,” “will,” and similar expressions are intended to identify our forward-looking statements, including but not limited to those related to our strategy, in particular, our unrivaled brand portfolio, top-tier shareholder returns and financial results, substained profitable growth, robust top-line growth, overhead and cost savings, Post Cereals split-off; new food law regulations; our workforce and authorities; our properties; our combination with Cadbury, including expected receivables, intangible assets, synergies, cost savings and integration charges; our long-term strategy; with regard to our Restructuring Program, our expected cash payments for charges and cumulative annualized savings; the Venezuelan currency devaluation; asset impairments; our legal proceedings, including environmental remedial actions; our pension plans and other employee benefit plans, including expected contributions, obligations and costs; commodity costs; our liquidity, effects of guarantees on our liquidity and funding sources; future acquisitions and divestitures; our capital expenditures and funding; our revolving credit facility and long-term debt covenants; our plan to file an automatic shelf registration statement; our aggregate contractual obligations; our 2012 Outlook, including the challenging operating environment and consumer weakness, our strong business momentum, organic net revenue growth and Operating EPS; and our risk management program, including the use of financial instruments for hedging activities.

These forward-looking statements are subject to a number of 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 in our forward-looking statements. Such factors include, but are not limited to, continued volatility of, and sharp increase in, commodity and other input costs, pricing actions, increased competition, our ability to differentiate our products from retailer brands, increased costs of sales, our indebtedness and our ability to pay our indebtedness, unexpected safety or manufacturing issues, regulatory or legal restrictions, actions or delays, unanticipated expenses such as litigation or legal settlement expenses, a shift in our product mix to lower margin offerings, risks from operating internationally, continued consumer weakness, weakness in economic conditions, our failure to successfully integrate the Cadbury business, performance in developing markets and tax law changes. We disclaim and do not undertake any obligation to update or revise any forward-looking statement in this report.

PART I

Item 1.  Business.

General

Kraft Foods is the world’s second largest food company with revenues of $49.2 billion and earnings from continuing operations before income taxes of $3.6 billion in 2010. Kraft Foods was incorporated in 2000 in the Commonwealth of Virginia. We have approximately 127,000 employees worldwide, and we manufacture and market packaged food products, including biscuits, confectionery, beverages, cheese, convenient meals and various packaged grocery products. We sell our products to consumers in approximately 170 countries. At December 31, 2010, we had operations in more than 75 countries and made our products at 223 manufacturing and processing facilities worldwide. At December 31, 2010, we had net assets of $35.9 billion and gross assets of $95.3 billion. We are a member of the Dow Jones Industrial Average, Standard & Poor’s 500, the Dow Jones Sustainability Index and the Ethibel Sustainability Index.

At December 31, 2010, our portfolio included eleven brands with annual revenues exceeding $1 billion each: Oreo, Nabisco and LU biscuits; Milka and Cadbury chocolates; Trident gum; Jacobs and Maxwell House coffees; Philadelphia cream cheeses; Kraft cheeses, dinners and dressings; and Oscar Mayer meats. Our portfolio included approximately 70 brands which each generate annual revenues of more than $100 million.

Because Kraft Foods Inc. is a holding company, our principal source of funds is from our subsidiaries. Our 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 manage and report operating results through three geographic units: Kraft Foods North America, Kraft Foods Europe and Kraft Foods Developing Markets. We manage the operations of Kraft Foods North America and Kraft

 

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Foods Europe by product category, and we manage the operations of Kraft Foods Developing Markets by location. Our reportable segments are U.S. Beverages, U.S. Cheese, U.S. Convenient Meals, U.S. Grocery, U.S. Snacks, Canada & North America Foodservice, Kraft Foods Europe and Kraft Foods Developing Markets. The results of operations from our Cadbury Limited (formerly, Cadbury plc) (“Cadbury”) acquisition are reflected within our U.S. Snacks, Canada & N.A. Foodservice, Kraft Foods Europe and Kraft Foods Developing Markets segments.

Note 16, Segment Reporting, to our consolidated financial statements includes a breakout of net revenues, segment operating income, total assets, depreciation expense and capital expenditures by reportable segment, as well as a breakout of net revenues, long-lived assets and total assets by geographic region. Management uses segment operating income to evaluate segment performance and allocate resources. We believe it is appropriate to disclose this measure to help investors analyze segment performance and trends. Segment operating income excludes unrealized gains and losses on hedging activities (which are a component of cost of sales), certain components of our U.S. pension plan cost (which is a component of cost of sales and selling, general and administrative expenses), general corporate expenses (which are a component of selling, general and administrative expenses) and amortization of intangibles.

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

 

Convenient Convenient Convenient Convenient Convenient Convenient Convenient
            For the Years Ended December 31,                       
                2010              2009              2008                           
           

(2009 & 2008 revised)

                      

Kraft Foods North America:

                    

U.S. Beverages

        8.4%         9.3%         9.3%            

U.S. Cheese

        8.9%         12.2%         13.7%            

U.S. Convenient Meals

        4.0%         4.3%         3.1%            

U.S. Grocery

        17.3%         21.0%         24.6%            

U.S. Snacks

        12.6%         13.2%         15.5%            

Canada & N.A. Foodservice

        8.7%         8.5%         9.6%            

Kraft Foods Europe

        16.6%         14.4%         4.4%            

Kraft Foods Developing Markets

        23.5%         17.1%         19.8%            
                                      

Total Kraft Segment Operating Income

         100.0%          100.0%          100.0%            
                                      

 

Our brands span six consumer sectors:

  

              

 

•     Biscuits - primarily cookies, crackers and salted snacks

•     Confectionery - primarily chocolate, gum and candy

•     Beverages - primarily coffee, packaged juice drinks and powdered beverages

•     Cheese - primarily natural, processed and cream cheeses

•     Grocery - primarily spoonable and pourable dressings, condiments and desserts

•     Convenient Meals - primarily processed meats, packaged dinners and lunch combinations

 

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

 

       

       

       

       

       

       

  

     Percentage of 2010 Net Revenues by Consumer Sector (1)  
                    Segment                         Biscuits(2)      Confect-
ionery(2)
     Beverages      Cheese      Grocery      Convenient
Meals
     Total  

Kraft Foods North America:

                    

U.S. Beverages

     -            -            36.5%         -            -            -            6.5%   

U.S. Cheese

     -            -            -            50.6%         -            -            7.2%   

U.S. Convenient Meals

     -            -            -            -            -            63.2%         6.4%   

U.S. Grocery

     -            1.0%         -            -            54.0%         22.1%         6.9%   

U.S. Snacks

     44.5%         7.8%         -            0.9%         1.8%         -            12.2%   

Canada & N.A. Foodservice

     7.9%         4.4%         6.0%         21.5%         21.4%         7.3%         9.5%   
                                                              

Total Kraft Foods North
America

     52.4%         13.2%         42.5%         73.0%         77.2%         92.6%         48.7%   
                                                              

Kraft Foods Europe

     21.5%         38.2%         28.7%         14.0%         8.3%         4.9%         23.6%   

Kraft Foods Developing Markets

     26.1%         48.6%         28.8%         13.0%         14.5%         2.5%         27.7%   
                                                              

Total Kraft Foods

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

Consumer Sector Percentage
of Total Kraft Foods

         21.9%             27.8%           17.9%             14.2%             8.1%         10.1%           100.0%   
                                                              

 

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  (1) Percentages were calculated based upon dollars rounded to millions.
  (2) We previously reported Biscuits and Confectionery combined as Snacks. With the Cadbury acquisition, the Biscuits and Confectionery sectors have been broken out separately. The Biscuits sector primarily includes Cookies, Crackers and Salted Snacks. The Confectionery sector primarily includes Chocolate, Gum and Candy.

Our U.S. subsidiaries export coffee products, refreshment beverage products, grocery products, cheese, biscuits and processed meats. In 2010, these U.S. exports amounted to $563 million.

Products or similar products contributing 10% or more to Kraft Foods’ consolidated net revenues for the years ended December 31, were:

 

             2010              2009              2008                
         (2009 & 2008 revised)            
 

Biscuits (cookies and crackers)

     19%         23%         23%         
 

Cheese

     14%         18%         18%         
 

Coffee

     11%         13%         14%         
 

Chocolate

     17%         11%         11%         
 

Gum & Candy

     10%         -             -             

Our major brands within each reportable segment and consumer sector at December 31, 2010 were:

 

Kraft Foods North America:

U.S. Beverages

   

Beverages:

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

U.S. Cheese

   

Cheese:

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

U.S. Convenient Meals

   

Convenient Meals:

    Oscar Mayer and Louis Rich cold cuts, hot dogs and bacon; Lunchables lunch combinations; Boca soy-based meat alternatives; Deli Creations complete sandwiches; and Claussen pickles.

U.S. Grocery

   

Grocery:

    Jell-O dry packaged desserts; Cool Whip whipped topping; Jell-O refrigerated gelatin and pudding snacks; Jet-Puffed marshmallows; 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 Baker’s chocolate and baking ingredients.

Convenient Meals:

    Kraft and Kraft Deluxe macaroni and cheese dinners; Stove Top stuffing mix; Taco Bell Home Originals (under license) meal kits; and Velveeta shells and cheese dinners.

U.S. Snacks

   

Biscuits:

    Oreo, Chips Ahoy!, Newtons, Nilla, Nutter Butter and SnackWell’s cookies; Ritz, Premium, Triscuit, Wheat Thins, Cheese Nips, Flavor Originals, Honey Maid grahams, Teddy Grahams crackers, Nabisco 100 Calorie Packs; Planters nuts and trail mixes; Handi-Snacks two-compartment snacks; and Back to Nature granola, cookies, crackers, nuts and fruit & nut mixes.

Confectionery:

    Toblerone, Trident, Halls, Stride, Dentyne, Sour Patch Kids, Swedish Fish, Maynards, Bubbas, Chiclets, Milka bars, and Clorets.

Canada & N.A. Foodservice

    Canada & N.A Foodservice products span all Kraft Foods North America segments and sectors. Canadian brand offerings include Nabob coffee, Kraft peanut butter and Peek Freans biscuits, as well as a range of products bearing brand names similar to those marketed in the U.S. The N.A. Foodservice business sells primarily branded products including Maxwell House coffee, Oreo cookies, A.1. steak sauce, and a broad array of Kraft sauces, dressings and cheeses.

 

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Kraft Foods Europe:

Biscuits:

     Oreo, Digestive, Tuc, Mini-Star, Mikado (under license), Ourson, Petit Déjeuner, Cracotte, Belin, Heudebert, Grany, Petit Écolier, Saiwa, Oro, Fonzies, Start, Prince and Belvita biscuits.

Confectionery:

     Milka, Marabou, Cote D’or, Toblerone, Freia, Suchard, Lacta, Pavlides,Mirabell chocolate confectionery products, Terry’s, Daim / Dime, Twist, Cadbury Dairy Milk, Roses, Creme Egg, Twirl, Flake, Crunchie, Heroes / Favourites, Wispa, Mini Eggs, Green and Black’s, Buttons, Milk Tray, Poulain, Giant Buttons, Double Decker, Moro / Boost, Timeout, Trident, Hollywood, Stimorol, Halls, Bassetts, Maynards, Trebor, Carambar, Poulain, La Pie Qui Chante, V6, TNCC, Eclairs, Malabar, Bubbas.

Beverages:

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

Cheese:

     Dairylea, Sottilette, Osella 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; Mirácoli pasta dinners and sauces; and Simmenthal canned meats.

Kraft Foods Developing Markets:

Biscuits:

     Oreo, Chips Ahoy!, Ritz, Club Social, Express, Kraker Bran, Honey Bran, Aveny Bran, Marbu, Variedad, Pacific, Belvita, Cerealitas, Lucky, Trakinas, Tuc, Mikado (under license), Ourson, Petit Déjeuner, Cracotte, Bolshevik, Prichuda, Jubilee, Major, Merendina, Jacob’s, Chipsmore, Twisties, Biskuat / Tiger, Milk Biscuit, Hi Calcium Soda, Pépito, Gyori and PIM’s biscuits; and Estrella, Kar, Lux and Planters nuts and salted snacks.

Confectionery:

     Milka, Toblerone, Lacta, Côte d’Or, Recaldent, Terrabusi, Kent, Kan, Alpen Gold, Korona, Poiana, Svoge, Vozdushny, Figaro, Prince Polo / Siesta, Sport/Smash/Jazz/Moreni, Cadbury Dairy Milk, Picnic, 5 Star, Heroes / Favourites, Flake, Fundraising, Crunchie, Perk, Old Gold, Freddo, Cherry Ripe, Moro / Boost, Roses, Trident, Halls, Clorets, Bubbas, Dirol, Chiclets, Eclairs, Beldent, Dentyne, Recaldent, Xylicrystal, Falim, TNCC, tom Tom, Pascall, Chappies, First, Stride, Mentos, Stimorol

Cheese:

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

Grocery:

     Royal dry packaged desserts; 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 and cheese dinners.

Significant Acquisitions and Divestitures

Cadbury Acquisition:

On January 19, 2010, we announced the terms of our final offer for each outstanding ordinary share of Cadbury, including each ordinary share represented by an American Depositary Share (“Cadbury ADS”), and the Cadbury Board of Directors recommended that Cadbury shareholders accept the terms of the final offer. On February 2, 2010, all of the conditions to the offer were satisfied or validly waived, the initial offer period expired and a subsequent offer period immediately began. At that point, we had received acceptances of 71.73% of the outstanding Cadbury ordinary shares, including those represented by Cadbury ADSs (“Cadbury Shares”). As of June 1, 2010, we owned 100% of all outstanding Cadbury Shares. We believe the combination of Kraft Foods and Cadbury will create a global snacks powerhouse and an unrivaled portfolio of brands people love.

Under the terms of our final offer and the subsequent offer, we agreed to pay Cadbury shareholders 500 pence in cash and 0.1874 shares of Kraft Foods Common Stock per Cadbury ordinary share validly tendered and 2,000 pence in cash and 0.7496 shares of Kraft Foods Common Stock per Cadbury ADS validly tendered. This valued Cadbury at $18.5 billion, or approximately £11.6 billion (based on the average price of $28.36 for a share of Kraft Foods Common Stock on February 2, 2010 and an exchange rate of $1.595 per £1.00).

 

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On February 2, 2010, we acquired 71.73% of Cadbury Shares for $13.1 billion and the value attributed to noncontrolling interests was $5.4 billion. From February 2, 2010 through June 1, 2010, we acquired the remaining 28.27% of Cadbury Shares for $5.4 billion. We had a $38 million gain on noncontrolling interest acquired and recorded it within additional paid in capital.

Pizza Divestiture:

On March 1, 2010, we completed the sale of the assets of our North American frozen pizza business (“Frozen Pizza”) to Nestlé USA, Inc. (“Nestlé”) for $3.7 billion. Our Frozen Pizza business was a component of our U.S. Convenient Meals and Canada & N. A. Foodservice segments. The sale included the DiGiorno, Tombstone and Jack’s brands in the U.S., the Delissio brand in Canada and the California Pizza Kitchen trademark license. It also included two Wisconsin manufacturing facilities (Medford and Little Chute) and the leases for the pizza depots and delivery trucks. Approximately 3,600 of our employees transferred with the business to Nestlé. As a result of the divestiture, we recorded a gain on discontinued operations of $1,596 million, or $0.92 per diluted share, in 2010.

Post Cereals Split-off:

On August 4, 2008, we completed the split-off of the Post cereals business into Ralcorp Holdings, Inc., after an exchange with our shareholders. Accordingly, the Post cereals business prior period results were reflected as discontinued operations on the consolidated statement of earnings. The exchange was expected to be tax-free to participating shareholders for U.S. federal income tax purposes.

In this split-off transaction, approximately 46 million shares of Kraft Foods Common Stock were tendered for $1,644 million. Our shareholders had the option to exchange some or all of their shares of Kraft Foods Common Stock and receive shares of common stock of Cable Holdco, Inc. (“Cable Holdco”). Cable Holdco was our wholly owned subsidiary that owned certain assets and liabilities of the Post cereals business. In exchange for the contribution of the Post cereals business, Cable Holdco issued approximately $665 million in debt securities, issued shares of its common stock and assumed a $300 million credit facility. Upon closing, we used the cash equivalent net proceeds, approximately $960 million, to repay debt. As a result of the split-off, we recorded a gain on discontinued operations of $926 million, or $0.61 per diluted share, in 2008.

See Note 2, Acquisitions and Divestitures, to our consolidated financial statements for additional information on these transactions.

Customers

Our five largest customers accounted for approximately 26% of our net revenues in 2010 compared with 27% in 2009 and 2008. Our ten largest customers accounted for approximately 35% of our net revenues in 2010 compared with 36% in 2009 and 2008. One of our customers, Wal-Mart Stores, Inc., accounted for approximately 14% of our net revenues in 2010 compared with 16% in 2009 and 2008.

Seasonality

Demand for some of our products may be influenced by holidays, changes in seasons or other annual events. However, overall 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 have different profit objectives and some international competitors are 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 and Marketing

Our 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

 

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outlets. In general, the retail trade for food products is consolidating. We distribute our products 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 a combination of direct store delivery and warehouse delivery. Outside of North America, our products are distributed through warehouse delivery and through the services of independent sales offices and agents.

Our marketing efforts are conducted through three principal sets of activities: (i) consumer marketing in on-air, print, outdoor and digital media; (ii) consumer incentives such as coupons and contests; and (iii) trade promotions to support price features, displays and other merchandising of our products by our customers.

Raw Materials and Packaging

We purchase large quantities of commodities, including dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and sugar and other sweeteners. In addition, we use significant quantities of plastic, glass 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.

Significant cost items in chocolate confectionery products are cocoa and sugar. We purchase cocoa and sugar on world markets, and their prices are affected by the quality and availability of supply and changes in the value of the pound sterling and the U.S. dollar relative to certain other currencies. Cocoa bean, cocoa butter and sugar costs on average were higher in 2010 than in 2009. We purchase 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 products are substantially influenced by market supply and demand, as well as by government programs. Dairy commodity costs on average were higher in 2010 than in 2009. The most significant cost item in coffee products is green coffee beans, which we purchase on world markets. Green coffee bean prices are affected by the quality and availability of supply, changes in the value of the U.S. dollar in relation to certain other currencies and consumer demand for coffee products. Green coffee bean costs on average were higher in 2010 than in 2009. Significant cost items in our biscuit and grocery products are grains (wheat, corn and soybean oil). Grain costs have experienced significant volatility as a result of burgeoning global demand for food, livestock feed and biofuels such as ethanol and biodiesel. Grain costs on average decreased from 2009 to 2010.

During 2010, our aggregate commodity costs increased primarily as a result of higher cocoa, sugar, dairy, coffee and meat costs, partially offset by lower grain costs. For 2010, our commodity costs were approximately $1.0 billion higher than 2009, following a decrease of approximately $150 million in 2009 compared to 2008. Overall, we expect commodity costs to continue to be volatile and to further increase in 2011.

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 renewable, fixed 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 products under brands we license from third parties, including at December 31, 2010:

 

   

Starbucks coffee and Seattle’s Best coffee for sale in U.S. and European grocery stores and other distribution channels;

   

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

   

Capri Sun packaged juice drinks for sale in the U.S. and Canada; and

   

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

 

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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 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 approximately 3,300 food scientists, chemists and engineers working primarily in 15 key technology centers: East Hanover, New Jersey; Glenview, Illinois; Madison, Wisconsin; Tarrytown, New York; Whippany, New Jersey; Banbury, United Kingdom; Bournville, United Kingdom; Curitiba, Brazil; Eysins, Switzerland; Paris, France; Melbourne, Australia; Mexico City, Mexico; Munich, Germany; Reading, United Kingdom; and Suzhou, China. These technology centers are equipped with pilot plants and state-of-the-art instruments. Research and development expense was $583 million in 2010, $466 million in 2009, and $487 million in 2008.

Regulation

Our U.S. food products and packaging materials are primarily regulated by the U.S. Food and Drug Administration (“FDA”) or, for products containing meat and poultry, the U.S. 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. We supported the recently enacted law that provides additional food safety authority to the FDA. We do not expect the cost of complying with that law, and implementing regulations expected over the next two to three years, to be material.

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 periodic U.S. 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 European Union, we must comply with requirements that apply to labeling, packaging, food content, pricing, marketing and advertising and related areas.

Environmental Regulation

We are subject to various laws and regulations in and outside of the U.S. 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 recovery of those costs is deemed probable.

 

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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 (the environmental program established in the Comprehensive Environmental Response Compensation, and Recovery Act to address abandoned hazardous waste sites), which imposes joint and severable liability on each potentially responsible party. At December 31, 2010, our subsidiaries were involved in 74 active actions in the U.S. under Superfund legislation (and other similar actions and legislation) 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 countries in which we do business. Outside the U.S., we have specific programs across our business units designed to meet applicable environmental compliance requirements.

As of December 31, 2010, we had accrued an insignificant amount for environmental remediation. 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 remedial actions.

Employees

At December 31, 2010, we employed approximately 127,000 people worldwide. Labor unions represent approximately 27% of our 37,000 U.S. employees. Most of the unionized workers at our U.S. 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 90,000 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 business unit. In addition, in accordance with European Union requirements, we have established a European Works Council composed of management and elected members of our workforce. We believe that our relationships with employees and their representative organizations are good.

Foreign Operations

We sell our products to consumers in approximately 170 countries. At December 31, 2010, we had operations in more than 75 countries and made our products at 223 manufacturing and processing facilities worldwide. We generated approximately 57% of our 2010 net revenues, 49% of our 2009 net revenues and 50% of our 2008 net revenues outside the U.S.

Refer to Note 16. Segment Reporting for additional information on our foreign operations.

For a discussion of risks attendant to our foreign operations, see “Risk Factors” in Item 1A.

Executive Officers of the Registrant

The following are our executive officers as of February 28, 2011:

 

Name

     Age       

Title

Irene B. Rosenfeld

    57      Chairman and Chief Executive Officer

David A. Brearton

    50      Executive Vice President, Operations and Business Services

Michael A. Clarke

    46      Executive Vice President and President, Kraft Foods Europe

Marc S. Firestone

    51      Executive Vice President, Corporate and Legal Affairs and General Counsel

Sanjay Khosla

    59      Executive Vice President and President, Developing Markets

Karen J. May

    52      Executive Vice President, Global Human Resources

Timothy R. McLevish

    55      Executive Vice President and Chief Financial Officer

Sam B. Rovit

    53      Executive Vice President, Strategy

Jean E. Spence

    53      Executive Vice President, Research, Development and Quality

W. Anthony Vernon

    55      Executive Vice President and President, Kraft Foods North America

Mary Beth West

    48      Executive Vice President and Chief Category and Marketing Officer

 

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Ms. Rosenfeld was appointed Chief Executive Officer and a member of the Board of Directors of Kraft Foods in June 2006 and Chairman of the Board in March 2007. Prior to that, she had been Chairman and Chief Executive Officer of Frito-Lay, a division of PepsiCo, Inc., a food and beverage company, from September 2004 to June 2006. Previously, Ms. Rosenfeld was employed continuously by Kraft Foods, and its predecessor, General Foods Corporation, in various capacities from 1981 until 2003, including President of Kraft Foods North America and, before that, President of Operations, Technology, Information Systems of Kraft Foods Canada, Mexico, and Puerto Rico. She is also a Trustee of Cornell University.

Mr. Brearton was appointed as Executive Vice President, Operations and Business Services effective January 1, 2008. Prior to that, he served as Executive Vice President, Global Business Services and Strategy from April 2006 to December 2007 and as Senior Vice President of Business Process Simplification and as Corporate Controller from February 2005 to April 2006. He previously served as a Senior Vice President, Finance for Kraft Foods International. Mr. Brearton joined Kraft Foods in 1984. Mr. Brearton also serves on the Board of Directors of Feeding America.

Mr. Clarke joined Kraft Foods as President, Kraft Foods Europe on January 2, 2009 and was appointed Executive Vice President and President, Kraft Foods Europe on January 27, 2009. Prior to joining Kraft Foods, Mr. Clarke spent 12 years with The Coca-Cola Company, a beverage company, most recently serving as President of the Northwest Europe and Nordics businesses from August 2005 to December 2008 and as President of the South Pacific and Korea businesses from March 2000 to July 2005. Mr. Clarke also serves on the Advisory Board of the Inspire Foundation.

Mr. Firestone was appointed as Executive Vice President, Corporate and Legal Affairs and General Counsel in October 2006. He previously served as Kraft Foods’ Executive Vice President, General Counsel and Corporate Secretary from November 2003 to October 2006. Prior to joining Kraft Foods in 2003, Mr. Firestone served as Senior Vice President and General Counsel of Philip Morris International, a tobacco company. Mr. Firestone also serves on the Board of Directors of Unilife Corporation.

Mr. Khosla was appointed as Executive Vice President and President, Developing Markets effective August 1, 2010. Prior to that, he served as Executive Vice President and President, Kraft Foods International from January 2007 to July 2010. Before joining Kraft Foods, he served as the Managing Director of Fonterra Brands, a dairy company, from 2004 to 2006. Previously, Mr. Khosla spent 27 years with Unilever, a consumer products company, in India, London and Europe. Mr. Khosla also serves on the Boards of Directors of Best Buy Co., Inc. and NIIT Ltd. and is a trustee of the Goodman Theater Company in Chicago.

Ms. May was appointed as Executive Vice President, Global Human Resources in October 2005. Prior to that, she had been Corporate Vice President, Human Resources for Baxter International Inc., a healthcare company, since February 2001. Ms. May also 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 Senior Vice President and Chief Financial Officer at Ingersoll-Rand Company Limited, an industrial company, since June 2002. Mr. McLevish also serves on the Board of Directors of Kennametal Inc.

Mr. Rovit was appointed Executive Vice President, Strategy effective February 1, 2011. Prior to joining Kraft Foods, he served as a Director of Bain & Co., a management consulting firm, from January 2008 to January 2011 and from 1988 to June 2005. Mr. Rovit served as President, Chief Executive Officer and Director of Swift & Company, a meat processing company, from June 2005 to July 2007. Mr. Rovit also serves on the Boards of Directors of MRC, Inc. and J. W. Saxe Memorial Fund.

Ms. Spence was appointed as Executive Vice President, Research, Development and Quality in January 2004. Prior to that, Ms. Spence served as Senior Vice President, Research and Development, Kraft Foods North America from August 2003 to January 2004 and Senior Vice President of Worldwide Quality, Scientific Affairs and Compliance for Kraft Foods North America from November 2001 to August 2003. She joined Kraft Foods in 1981. Ms. Spence also serves on the Board of Directors of International Life Sciences Institute.

Mr. Vernon joined Kraft Foods as Executive Vice President and President, Kraft Foods North America in August 2009. Prior to that, he was the Healthcare Industry Partner of Ripplewood Holdings Inc., a private equity firm, since

 

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2006. Mr. Vernon spent 23 years with Johnson & Johnson, a pharmaceutical company, in a variety of leadership positions, most recently serving as Company Group Chairman of DePuy Inc., an orthopedics company and subsidiary of Johnson & Johnson, from 2004 to 2005. Mr. Vernon also serves on the Board of Directors of Medivation, Inc.

Ms. West was appointed as Executive Vice President and Chief Category and Marketing Officer effective August 1, 2010. Previously, she served as Executive Vice President and Chief Marketing Officer from October 2007 to July 2010, and as Group Vice President for Kraft Foods and President of the North America Beverages Sector from 2005 to October 2007. Ms. West joined Kraft Foods in 1986. Ms. West also serves on the Board of Directors of J.C. Penney Co., Inc. and is a member of the Executive Leadership Council.

We adopted the Kraft Foods Code of Conduct, 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 Web site at www.kraftfoodscompany.com and will be provided free of charge to any shareholder 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 Web site at www.kraftfoodscompany.com.

In addition, we adopted Corporate Governance Guidelines, charters for each of the Board’s five standing committees and the Code of Business Conduct and Ethics for Directors. All of these materials are available on our Web site at www.kraftfoodscompany.com and will be provided free of charge to any shareholder requesting a copy by writing to: Corporate Secretary, Kraft Foods Inc., Three Lakes Drive, Northfield, IL 60093.

Available Information

Our Internet address is www.kraftfoodscompany.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 www.kraftfoodscompany.com. The information on our Web site 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, including Kraft Foods, that are electronically filed with the SEC.

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 and 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.

The food industry is highly 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.

We may need to reduce our prices in response to competitive and customer pressures in order to maintain our market share. Competition and customer pressures may also restrict our ability to increase prices in response to

 

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commodity and other cost increases. We may also need to increase or reallocate spending on marketing, advertising and new product innovation to protect or increase market share. These expenditures are subject to risks, including uncertainties about trade and consumer acceptance of our efforts. Despite these expenditures, we may not successfully maintain or enhance market share. If we reduce prices or increase costs, but we cannot increase sales volumes to offset those changes, then our financial condition and results of operations will suffer.

Maintaining our reputation and brand image is essential to our business success.

Many of our brands are iconic, with worldwide recognition. Our success depends on our ability to maintain brand image for our existing products, extend our brands to new platforms and expand our brand image with new product offerings.

We seek to maintain, extend and expand our brand image through marketing investments, including advertising and consumer promotions, and product innovation. Continuing global focus on health and wellness, including weight management, and increasing media attention to the role of food marketing could adversely affect our brand image or lead to stricter regulations and greater scrutiny of food marketing practices. Increased legal or regulatory restrictions on our advertising, consumer promotions and marketing, or our response to such restrictions, could limit our efforts to maintain, extend and expand our brands. Moreover, adverse publicity about regulatory or legal action against us could damage our reputation and brand image, undermine our customers’ confidence and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations.

In addition, our success in maintaining, extending and expanding our brand image depends on our ability to adapt to a rapidly changing media environment, including our increasing reliance on social media and online dissemination of advertising campaigns. We are subject to a variety of legal and regulatory restrictions on how and to whom we market our products, for instance marketing to children. These restrictions may limit our ability to maintain, extend and expand our brand image as the media and communications environment continues to evolve. If we do not maintain, extend and expand our brand image, then our product sales, financial condition and results of operations could be materially and adversely affected.

We must leverage our value proposition to compete against retailer brands and other economy brands.

Retailers are increasingly offering retailer and other economy brands that compete with some of our products. Our products must provide higher value and / or quality to our consumers than less expensive alternatives, particularly during periods of economic uncertainty such as those we continue to experience. Consumers may not buy our products if the difference in value or quality between our products and retailer or other economy brands narrows or if consumers perceive a narrowing. If consumers prefer retailer or other economy brands then we could lose market share or sales volumes or shift our product mix could shift to lower margin offerings. These effects could materially and adversely affect our financial condition and results of operations.

The consolidation of retail customers could adversely affect us.

Retail customers, such as supermarkets, warehouse clubs and food distributors in the U.S., the European Union and our other major markets, continue to consolidate, resulting in fewer customers on which we can rely for business. Consolidation also produces large, more sophisticated retail customers that can resist price increases and demand lower pricing, increased promotional programs or specifically tailored products. In addition, larger retailers have the scale to develop supply chains that permit them to operate with reduced inventories or to develop and market their own retailer brands. Further retail consolidation may materially and adversely affect our product sales, financial condition and results of operations.

Retail consolidation also increases the risk that adverse changes in our customers’ business operations or financial performance will have a corresponding material adverse effect on us. For example, if our customers do not have access to sufficient funds or financing, then they may delay, decrease or cancel purchases of our products, or delay or refuse to pay us for previous purchases.

Changes in our relationships with significant customers or suppliers could adversely affect us.

During 2010, our five largest customers accounted for approximately 26% of our net revenues with our largest customer Wal-Mart Stores, Inc., accounting for approximately 14% of our net revenues. There can be no assurance that all significant customers will continue to purchase our products in the same quantities or on the same terms as in the past. The loss of a significant customer or a material reduction in sales to a significant customer could materially and adversely affect our product sales, financial condition and results of operations.

 

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Disputes with significant suppliers, including regarding pricing or performance, could adversely affect our ability to supply products to our customers and could materially and adversely affect our product sales, financial condition and results of operations.

Commodity and other input prices are volatile and may rise significantly.

We purchase large quantities of commodities, including dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and sugar and other sweeteners. In addition, we purchase and use significant quantities of plastic, glass and cardboard to package our products, and natural gas to operate our factories and warehouses. Prices for commodities, other supplies and energy are volatile and can fluctuate due to conditions that are difficult to predict, including global competition for resources, currency fluctuations, severe weather, consumer demand and changes in governmental trade and agricultural programs. For example, unusually adverse weather conditions, such as the heat wave in the grain growing regions of Russia and Ukraine and recent severe drought in the grain growing regions of China, have contributed to rising wheat and corn costs in 2010 and we expect such conditions to continue in 2011. For 2010, our commodity costs were approximately $1.0 billion higher than 2009. Although we monitor our exposure to commodity prices as an integral part of our overall risk management program, and seek to hedge against price increases, continued volatility in the prices of commodities and other supplies we purchase could increase the costs of our products, and our profitability could suffer. Moreover, price increases to cover these increased costs may result in lower sales volumes. If we are not successful in our hedging activities, or if we are unable to price to cover increased costs, then commodity and other input price volatility or increases could materially and adversely affect our financial condition and results of operations.

Changes in regulations could increase our costs and affect our profitability.

Our activities in the United States and around the world are highly regulated and subject to government oversight. Various federal, state, provincial and local laws and regulations govern food production and marketing, as well as licensing, trade, tax and environmental matters. Governing bodies regularly issue new regulations and changes to existing regulations. Our need to comply with new or revised regulations or their interpretation and application, including proposed requirements designed to enhance food safety or to regulate imported ingredients, could materially and adversely affect our product sales, financial condition and results of operations.

Legal claims or other regulatory enforcement actions could subject us to civil and criminal penalties that affect our product sales, reputation and profitability.

We are a large food company that operates in a highly regulated, highly competitive environment with growing retailer power and a constantly evolving legal and regulatory framework around the world. Consequently, we are subject to heightened risk of legal claims or other regulatory enforcement actions. Although we have implemented policies and procedures designed to ensure compliance with existing laws and regulations, there can be no assurance that our employees, contractors or agents will not violate our policies and procedures. Moreover, the failure to maintain effective control environment processes could lead to violations, unintentional or otherwise, of laws and regulations. Legal claims or regulatory enforcement actions arising out of our failure or alleged failure to comply with applicable laws and regulations could subject us to civil and criminal penalties that could materially and adversely affect our product sales, reputation and profitability.

Product recalls or other product liability claims could materially and adversely affect us.

Selling products for human consumption involves inherent risks. We could decide to, or be required to recall products due to suspected or confirmed product contamination, spoilage or other adulteration, product misbranding or product tampering. Any of these events could adversely affect our reputation and product sales, financial condition or results of operations.

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 marketing could be the target of claims of false or deceptive advertising or other criticism. A significant product liability or other legal judgment or a related regulatory enforcement action against us, or a widespread product recall, may materially and 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 materially and adversely affect our product sales, financial condition and results of operations.

 

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We are subject to risks generally associated with companies that operate in a global environment, which could affect our growth and financial performance.

We generated approximately 57% of our 2010 net revenues, 49% of our 2009 net revenues and 50% of our 2008 net revenues outside the U.S. With operations in more than 75 countries, our operations are subject to risks inherent in multinational operations. Those risks include:

 

   

compliance with U.S. laws affecting operations outside of the U.S., such as the Foreign Corrupt Practices Act,

   

compliance with a variety of local regulations and laws,

   

changes in tax laws and the interpretation of those laws,

   

fluctuations in currency values,

   

sudden changes in foreign currency exchange controls,

   

discriminatory or conflicting fiscal policies,

   

difficulties enforcing intellectual property and contractual rights in certain jurisdictions,

   

greater risk of uncollectible accounts and longer collection cycles,

   

effective and immediate implementation of control environment processes across our diverse operations, and

   

imposition of more or new tariff, quotas, trade barriers, and similar restrictions on our sales outside the U.S.

Moreover, political and economic changes or volatility, geopolitical regional conflicts, terrorist activity, political unrest, civil strife, acts of war, public corruption and other economic or political uncertainties could interrupt and negatively affect our business operations. All of these factors could result in increased costs or decreased revenues, and could materially and adversely affect our product sales, financial condition and results of operations.

Our operations in certain developing markets expose us to political, economic and regulatory risks.

Our growth strategy depends in part on our ability to expand our operations in developing markets, including Brazil, China, India, Mexico, Russia and Southeast Asia. However, some developing markets have greater political and economic volatility and greater vulnerability to infrastructure and labor disruptions than established markets. In many countries outside of the U.S., particularly in those with developing economies, it may be common for others to engage in business practices prohibited by laws and regulations applicable to us, such as the Foreign Corrupt Practices Act or similar local anti-bribery laws. These laws generally prohibit companies and their employees, contractors or agents from making improper payments to government officials for the purpose of obtaining or retaining business. Failure to comply with these laws could subject us to civil and criminal penalties that could materially and adversely affect our financial condition and results of operations.

In addition, competition in developing markets is increasing as our competitors grow their global operations and low cost local manufacturers expand their production capacities. Our success in integrating Cadbury’s operations and products, many of which have a strong presence in a number of developing markets, is critical to our growth strategy. If we cannot successfully increase our business in developing markets, our product sales, financial condition and results of operations could be materially and adversely affected.

Unanticipated business disruptions could affect our ability to provide our products to our customers.

We have a complex network of suppliers, owned manufacturing locations, co-manufacturing locations, distribution networks and information systems that support our ability consistently to provide our products to our customers. Factors that are hard to predict or beyond our control, like weather, natural disasters, fire, terrorism, generalized labor unrest or health pandemics, could damage or disrupt our operations, or our suppliers’ or co-manufacturers’ operations. If we are unable to respond to disruptions in our operations, whether by finding alternative suppliers or replacing capacity at key manufacturing or distribution locations, or are unable to quickly repair damage to our information, production or supply systems, we may be late or unable to deliver products to our customers. If that were to occur, our customers’ confidence in us and long-term demand for our products could decline. Any of these events could materially and adversely affect our product sales, financial condition and results of operations.

We must correctly predict, identify and interpret changes in consumer preferences and demand, and offer new products to meet those changes.

Consumer preferences for food products change continually. 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 consumer preferences. If we do not offer products that appeal to consumers, our sales and market share will decrease and our profitability could suffer.

 

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We must distinguish among short-term fads, mid-term trends and long-term changes in consumer preferences. If we do not 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 could decline. In addition, because of our varied consumer base, we must offer an array of products sufficient to satisfy the broad spectrum of consumer preferences. If we fail to expand our product offerings successfully across 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.

Prolonged negative perceptions concerning the health implications of certain food products could influence consumer preferences and acceptance of some of our products and marketing programs. For example, recently, consumers have been increasingly focused on health and wellness, including weight management and reducing sodium consumption. We strive to respond to consumer preferences and social expectations, but we may be unsuccessful in these efforts. Continued negative perceptions and failure to satisfy consumer preferences could materially and adversely affect our product sales, financial condition and results of operations.

Increased or unanticipated costs or difficulties encountered in our continuing integration of Cadbury could affect our results of operations.

We continue to integrate the operations of our Cadbury business into our existing business. We expect the anticipated synergies of integration to increase revenues and operating results through enhanced growth opportunities and increased cost savings. If we encounter difficulties in fully integrating the businesses, it could delay or we could fail to achieve anticipated synergies and cost savings, including the expected increases in revenues and operating results. If the difficulties are significant, our financial condition and results of operations could be materially and adversely affected.

Additionally, we expect to incur a number of non-recurring costs associated with combining our operations, including implementation cash costs that we estimate will be approximately $1.5 billion in the first three years following completion of the acquisition. Delays in integrating the businesses could cause such costs to be significantly higher than anticipated.

We may not successfully complete proposed acquisitions or divestitures or integrate acquired businesses.

From time to time, we evaluate acquisition candidates that may strategically fit our business objectives. If we are unable to complete acquisitions or to successfully integrate and develop acquired businesses, including Cadbury, our financial results could be materially and adversely affected. In addition, we may divest businesses that do not meet our strategic objectives, or do not meet our growth or profitability targets. We may not be able to complete desired or proposed divestitures on terms favorable to us. Gains or losses on the sales of, or lost operating income from, those businesses may affect our profitability. Moreover, we may incur asset impairment charges related to acquisitions or divestitures that reduce our profitability.

Our acquisition or divestiture activities may present financial, managerial and operational risks. Those risks include diversion of management attention from existing core businesses, difficulties integrating or separating personnel and financial and other systems, effective and immediate implementation of control environment processes across our diverse employee population, 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 factors could affect our product sales, financial condition and results of operations.

We are subject to foreign currency exchange rate fluctuations.

Our acquisition of Cadbury and disposition of our Frozen Pizza business increased the portion of our assets, liabilities and earnings denominated in non-U.S. dollar currencies, which increased our exposure to currency exchange rate fluctuations. Our financial results and capital ratios are now more sensitive to movements in foreign exchange rates than in prior periods because a larger portion of our assets, liabilities, revenue and expenses must be translated into U.S. dollars for external reporting purposes. In addition, movements in foreign exchange rates can affect transaction costs because we source product ingredients from various countries. We may seek to mitigate our exposure to currency exchange rate fluctuations, but our efforts may not be successful. Accordingly, a depreciation of non-U.S. dollar currencies relative to the U.S. dollar, or changes in the relative value of any two currencies that we use for transactions, could materially and adversely affect our financial condition and results of operations.

 

14


Business process improvement initiatives to harmonize our systems and processes may fail to operate as designed and intended.

We regularly implement business process improvement initiatives designed to harmonize our systems and processes and improve our performance. Significant current business process improvement initiatives include reorganization of our European operations, delivery of a SAP enterprise resource planning application, and outsourcing certain administrative functions. Our business process improvement initiatives may not be successful, or may interfere with our core business operations or divert management attention from those operations. If we are unable to improve existing operations, achieve anticipated cost savings and support future growth, our product sales, financial condition and results of operations may be materially and adversely affected.

Downgrades in our credit ratings and other effects of volatile economic conditions on the credit market could reduce our liquidity or increase our borrowing costs and liquidity.

Our short- and long-term credit ratings affect our borrowing costs and access to financing. A downgrade in our credit ratings would increase our borrowing costs and could affect our ability to issue commercial paper. We access the commercial paper market for regular funding requirements. Disruptions in the commercial paper market or other effects of volatile economic conditions on the credit market also could reduce the amount of commercial paper that we could issue and could raise our borrowing costs for both short- and long-term debt offerings.

Volatility in the equity markets or interest rates could substantially increase our pension costs and have a negative impact on our operating results and profitability.

At the end of 2010, the projected benefit obligation of our defined benefit pension plans was $15.6 billion and assets were $13.3 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 affect the level of plan funding, cause volatility in the net periodic pension cost, and 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.

We expect to make approximately $940 million in contributions to our pension plans in 2011, which is approximately $550 million more than we made in 2010. We also expect that our net pension cost will remain flat at approximately $530 million in 2011. Volatile economic conditions increase the risk that we may be required to make additional cash contributions to the pension plans and recognize further increases in our net pension cost beyond 2011.

Item 1B.  Unresolved Staff Comments.

Not applicable.

Item 2.  Properties.

We have 223 manufacturing and processing facilities worldwide. This includes the 62 manufacturing and process facilities we obtained as part of our Cadbury acquisition. These facilities are located in 57 countries. We have 57 facilities in Kraft Foods North America, 59 in Kraft Foods Europe and 107 In Kraft Foods Developing Markets.

We own 214 and lease 9 of these manufacturing and processing facilities. It is our practice to maintain all of our plants and properties in good condition, and we believe they are suitable and adequate for our present needs.

We also have 236 distribution centers and depots worldwide. We own 51 of these distribution centers and depots, and we lease 185 of these distribution centers and depots. In North America, we have 139 distribution centers and depots, more than 60% of which support our direct store delivery systems. Outside North America, we have 97 distribution centers and depots in 29 countries.

 

15


These facilities are located throughout the following regions:

 

Manufacturing Manufacturing Manufacturing Manufacturing Manufacturing
   

Region

   Number of
Manufacturing
Facilities
     Number of
Distribution
Facilities
           
 

U.S.

     46         128       
 

Canada

     11         11       
 

Western Europe

     59         23       
 

Central & Eastern Europe, Middle East
and Africa

     50         8       
 

Latin America

     20         6       
 

Asia Pacific

     37         60       
                       
 

Total

     223         236       
                       

These facilities are in good condition, and we believe they have sufficient capacity to meet our distribution needs in the near term.

Item 3.  Legal Proceedings.

We routinely are involved in legal proceedings, claims, and governmental inspections or investigations (“Legal Matters”) arising in the ordinary course of our business.

On November 29, 2010, we initiated an arbitration proceeding against Starbucks Coffee Company (“Starbucks”) to challenge Starbucks attempt to end our retail coffee agreement without compensating us pursuant to the agreement’s termination provisions. On December 6, 2010, in a separate proceeding, we filed a motion for preliminary injunction in the U.S. District Court for the Southern District of New York against Starbucks to enjoin Starbucks from unilaterally terminating our agreement. The District Court denied our motion for preliminary injunction on January 28, 2011. On February 25, 2011, the U.S. Court of Appeals for the Second Circuit upheld the U.S. District Court’s ruling. Despite this ruling, our arbitration proceeding, which we are vigorously pursuing, will continue.

A compliant and ethical corporate culture, which includes adhering to laws and industry regulations in the United States and abroad, is integral to our success. To this end, after we acquired Cadbury in February 2010 we began reviewing and adjusting, as needed, Cadbury’s operations in light of U.S. and international standards as well as Kraft Foods’ policies and practices. We initially focused on such high priority areas as food safety, the Foreign Corrupt Practices Act (“FCPA”) and antitrust. Based upon Cadbury’s pre-acquisition policies and compliance programs and our post-acquisition reviews, our preliminary findings indicated that Cadbury’s overall state of compliance was sound. Nonetheless, through our reviews, we determined that in certain jurisdictions, including India, there appeared to be facts and circumstances warranting further investigation. We have undertaken these investigations, which are ongoing.

On February 1, 2011, we received a subpoena from the SEC. The subpoena, issued in connection with an investigation under the FCPA, primarily relates to a Cadbury facility in India that we acquired in the Cadbury acquisition and primarily requests information regarding dealings with Indian governmental agencies and officials to obtain approvals related to the operation of that facility. We are cooperating with the U.S. government in its investigation of these matters.

While we cannot predict with certainty the results of these or any other Legal Matters in which we are currently involved, we do not expect that the ultimate costs to resolve any of these matters will have effect on our financial results.

 

16


PART II

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

Our Common Stock is listed on the NYSE. At January 31, 2011, there were approximately 80,245 holders of record of our Common Stock.

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 shows total shareholder return assuming $100 was invested on December 31, 2004 and dividends were reinvested on a quarterly basis.

LOGO

 

NewPerformance NewPerformance NewPerformance NewPerformance

Date

   Kraft Foods      S&P 500      Old Performance
Peer Group
     New Performance
Peer Group
 

December 2005

     100.00         100.00         100.00         100.00   

December 2006

     130.45         115.76         120.15         121.31   

December 2007

     122.98         122.11         144.70         149.06   

December 2008

     105.08         77.00         116.84         118.08   

December 2009

     111.37         97.31         139.19         147.66   

December 2010

     134.16         111.95         157.37         170.25   

In 2010, we revised our peer performance group to only include food and beverage companies. As a result, we removed Clorox, Colgate-Palmolive, Diageo, and Procter & Gamble. Additionally, due to our Cadbury acquisition in 2010, we removed them from our performance peer group.

The Kraft Foods new 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: Campbell Soup Company, The Coca-Cola Company, ConAgra Foods, Inc., DANONE, General Mills, Inc., H.J. Heinz Company, Hershey Foods Corporation, Kellogg Company, Nestlé S.A., PepsiCo, Inc., Sara Lee Corporation, and Unilever N.V. The old performance peer group consisted of the following companies: Cadbury plc, Campbell Soup Company, The Clorox Company, The Coca-Cola Company, Colgate-Palmolive Company, ConAgra Foods, Inc., Diageo plc, General Mills, Inc., 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.

 

17


Portions of the information called for under Part II Item 5(a) are incorporated by reference to Note 17, Quarterly Financial Data (Unaudited), which is included within Item 8.

This performance 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 SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act of 1934, as amended.

Issuer Purchases of Equity Securities during the Quarter ended December 31, 2010

There are currently no share repurchase programs authorized by our Board of Directors. The following activity represents shares tendered by our employees who used shares to exercise options, and who used shares to pay the related taxes for grants of restricted and deferred stock that vested. Accordingly, these are non-cash transactions.

 

AveragenPricenPaid AveragenPricenPaid
     Total Number of
Shares
     Average Price Paid
per Share
 

October 1-31, 2010

     29,479       $ 31.06   

November 1-30, 2010

     5,471       $ 31.36   

December 1-31, 2010

     43,353       $ 31.06   
           

For the Quarter Ended
December 31, 2010

     78,303       $ 31.08   
           

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

18


Item 6.  Selected Financial Data.

Kraft Foods Inc.

Selected Financial Data—Five Year Review

(in millions of dollars, except per share and employee data)

 

     2010      2009      2008      2007      2006  

Summary of Operations:

              

Net revenues

    $ 49,207        $ 38,754        $ 40,492        $ 34,580        $ 31,849   

Cost of sales

           31,305               24,819               27,164               22,848               20,573   

Operating income

     5,666         5,183         3,576         3,939         3,935   

Operating margin

     11.5%         13.4%         8.8%         11.4%         12.4%   

Interest and other expense, net

     2,024         1,237         1,240         604         510   
                                            

Earnings from continuing operations
before income taxes

     3,642         3,946         2,336         3,335         3,425   

Provision for income taxes

     1,147         1,136         658         992         732   

Earnings and gain from discontinued operations, net of income taxes

     1,644         218         1,215         381         372   
                                            

Net earnings

     4,139         3,028         2,893         2,724         3,065   

Noncontrolling interest

     25         7         9         3         5   
                                            

Net earnings attributable to Kraft Foods

     4,114         3,021         2,884         2,721         3,060   

Basic EPS attributable to Kraft Foods:

              

Continuing operations

     1.44         1.90         1.11         1.47         1.62   

Discontinued operations

     0.96         0.14         0.81         0.24         0.22   
                                            

Net earnings attributable to Kraft Foods

     2.40         2.04         1.92         1.71         1.84   

Diluted EPS attributable to Kraft Foods:

              

Continuing operations

     1.44         1.89         1.10         1.46         1.62   

Discontinued operations

     0.95         0.14         0.80         0.24         0.22   
                                            

Net earnings attributable to Kraft Foods

     2.39         2.03         1.90         1.70         1.84   

Dividends declared per share

     1.16         1.16         1.12         1.04         0.96   

Dividends declared as a % of basic EPS

     48.3%         56.9%         58.3%         60.8%         52.2%   

Dividends declared as a % of diluted EPS

     48.5%         57.1%         58.9%         61.2%         52.2%   

Weighted-average shares - basic

     1,715         1,478         1,505         1,591         1,659   

Weighted-average shares - diluted

     1,720         1,486         1,515         1,600         1,661   

Net cash provided by operating activities

     3,748         5,084         4,141         3,571         3,720   

Capital expenditures

     1,661         1,330         1,367         1,241         1,169   

Free cash flow*

     2,087         3,754         2,774         2,330         2,551   

Depreciation

     1,229         905         963         873         884   

Property, plant and equipment, net

     13,792         10,693         9,917         10,778         9,693   

Inventories, net

     5,310         3,775         3,881         4,238         3,436   

Total assets

     95,289         66,714         63,173         68,132         55,548   

Long-term debt

     26,859         18,024         18,589         12,902         7,081   

Total debt

     28,724         18,990         20,251         21,009         10,821   

Total long-term liabilities

     43,687         29,251         29,773         23,574         16,520   

Total Kraft Foods shareholders’ equity

     35,834         25,876         22,295         27,407         28,536   

Total equity

     35,942         25,972         22,356         27,445         28,562   

Book value per common share outstanding

     20.50         17.51         15.18         17.87         17.44   

Market price per Common Stock
share - high / low

     32.67-27.09         29.84-20.81         34.97-24.75         37.20-29.95         36.67-27.44   

Closing price of Common Stock at
year end

     31.51         27.18         26.85         32.63         35.70   

Price / earnings ratio at year end - basic

     13         13         14         19         19   

Price / earnings ratio at year end - diluted

     13         13         14         19         19   

Shares outstanding at year end

     1,748         1,478         1,469         1,534         1,636   

Number of employees

     127,000         97,000         98,000         103,000         90,000   

 

* Please see Non-GAAP Financial Measures section at the end of Item 7.

 

19


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

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

Description of the Company

We market biscuits, confectionery, beverages, cheese, grocery products and convenient meals in approximately 170 countries.

Executive Summary

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

 

   

Net revenues in 2010 increased 27.0% to $49.2 billion. Net revenues in 2009 decreased 4.3% to $38.8 billion.

 

   

Diluted EPS attributable to Kraft Foods increased 17.7% to $2.39 in 2010 and increased 6.8% to $2.03 in 2009. Diluted EPS attributable to Kraft Foods from continuing operations decreased 23.8% to $1.44 in 2010 and increased 71.8% to $1.89 in 2009.

 

   

On February 2, 2010, we had received acceptances to our offer of 71.73% of the outstanding ordinary shares of Cadbury. From February 2, 2010 through June 1, 2010, we acquired the remaining 28.27% of Cadbury Shares. In acquiring Cadbury, we issued 262 million shares of our Common Stock and paid $10.9 billion in cash.

 

   

On February 8, 2010, we issued $9.5 billion of senior unsecured notes at a weighted-average effective rate of 5.364% and primarily used the net proceeds ($9,379 million) to finance the Cadbury acquisition.

 

   

On March 1, 2010, we completed the sale of the assets of our North American frozen pizza business to Nestlé USA, Inc. for $3.7 billion. Accordingly, the results of our Frozen Pizza business have been reflected as discontinued operations on the consolidated statement of earnings, and prior period results have been revised in a consistent manner.

 

   

On December 29, 2010, we repurchased $1.5 billion of our notes due in 2011 and 2012. We paid $1,596 million aggregate consideration, including accrued and unpaid interest, for the accepted notes.

 

   

On November 30, 2009, we entered into a revolving credit agreement for a $4.5 billion three-year senior unsecured revolving credit facility. The agreement replaced our former revolving credit agreement, which was terminated upon the signing of the new agreement.

 

   

Our $5.0 billion share repurchase authority expired on March 30, 2009. Prior to the expiration, we repurchased 130.9 million shares for $4.3 billion under the program. We did not repurchase any shares in 2010 or 2009.

 

   

In 2008, we completed our $2.9 billion, five-year Restructuring Program. We reversed previously accrued Restructuring Program charges of $37 million in 2010 and $85 million in 2009, and we recorded charges of $989 million during 2008.

 

   

On August 4, 2008, we completed the split-off of the Post cereals business. Accordingly, the Post cereals business prior period results were reflected as discontinued operations on the consolidated statement of earnings.

 

20


Discussion and Analysis

Strategy

We are seeking to build a global Snacks powerhouse with an unrivaled portfolio of brands people love. Our future growth is centered on three strategies: To delight global Snacks consumers; To unleash the Power of our Iconic Heritage Brands; and To Create a Performance-Driven, Values-Led Organization, which we believe will allow us to deliver top-tier shareholder returns. We plan to drive sustained, profitable growth that will put us among the top performers of our industry. Our strategic focus on global snacks, iconic heritage brands and our culture is intended to deliver robust top-line growth. Our ongoing overhead and cost saving efforts are fueling significant additional investments in marketing and innovation. We believe that these savings and investments, along with our emphasis on the importance of superior execution, will generate sustained growth. We believe we are well-positioned to deliver consistent financial results in the top-tier of our peer group.

Items Affecting Comparability of Financial Results

Acquisitions and Divestitures

Cadbury Acquisition:

On January 19, 2010, we announced the terms of our final offer for each outstanding ordinary share of Cadbury Limited (formerly, Cadbury plc) (“Cadbury”), including each ordinary share represented by an American Depositary Share (“Cadbury ADS”), and the Cadbury Board of Directors recommended that Cadbury shareholders accept the terms of the final offer. On February 2, 2010, all of the conditions to the offer were satisfied or validly waived, the initial offer period expired and a subsequent offer period immediately began. At that point, we had received acceptances of 71.73% of the outstanding Cadbury ordinary shares, including those represented by Cadbury ADSs (“Cadbury Shares”). As of June 1, 2010, we owned 100% of all outstanding Cadbury Shares. We believe the combination of Kraft Foods and Cadbury will create a global snacks powerhouse and an unrivaled portfolio of brands people love.

Under the terms of our final offer and the subsequent offer, we agreed to pay Cadbury shareholders 500 pence in cash and 0.1874 shares of Kraft Foods Common Stock per Cadbury ordinary share validly tendered and 2,000 pence in cash and 0.7496 shares of Kraft Foods Common Stock per Cadbury ADS validly tendered. This valued Cadbury at $18.5 billion, or approximately £11.6 billion (based on the average price of $28.36 for a share of Kraft Foods Common Stock on February 2, 2010 and an exchange rate of $1.595 per £1.00).

On February 2, 2010, we acquired 71.73% of Cadbury Shares for $13.1 billion and the value attributed to noncontrolling interests was $5.4 billion. From February 2, 2010 through June 1, 2010, we acquired the remaining 28.27% of Cadbury Shares for $5.4 billion. We had a $38 million gain on noncontrolling interest acquired and recorded it within additional paid in capital.

As part of our Cadbury acquisition, we incurred and expensed transaction related fees of $218 million in 2010 and $40 million in 2009. We recorded these expenses within selling, general and administrative expenses. We also incurred acquisition financing fees of $96 million in 2010. We recorded these expenses within interest and other expense, net.

Cadbury contributed net revenues of $9,143 million and net earnings of $530 million from February 2, 2010 through December 31, 2010. The following unaudited pro forma summary presents Kraft Foods’ consolidated information as if Cadbury had been acquired on January 1, 2009. These amounts were calculated after conversion to U.S. GAAP, applying our accounting policies, and adjusting Cadbury’s results to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant and equipment, and intangible assets had been applied from January 1, 2009, together with the consequential tax effects. These adjustments also reflect the additional interest expense incurred on the debt to finance the purchase, and the divestitures of certain Cadbury confectionery operations in Poland and Romania, as required by the EU Commission as a condition of our Cadbury acquisition.

 

     Pro forma for the
Years Ended December 31,
 
     2010      2009  
     (in millions)  

Net revenues

   $     49,770       $     47,852   

Net earnings attributable to Kraft Foods

     3,938         2,586   

 

21


Our February 2, 2010, Cadbury acquisition was valued at $18,547 million, or $17,503 million net of cash and cash equivalents. As part of that acquisition, we acquired the following assets and assumed the following liabilities (in millions):

 

00000000 00000000 00000000

Receivables (1)

   $           1,333        

Inventories

     1,298        

Other current assets

     660        

Property, plant and equipment

     3,293        

Goodwill (2)

     9,530        

Intangible assets (3)

     12,905        

Other assets

     593        

Short-term borrowings

     (1,206     

Accounts payable

     (1,605     

Other current liabilities (4)

     (1,866     

Long-term debt

     (2,437     

Deferred income taxes

     (3,218     

Accrued pension costs

     (817     

Other liabilities

     (927     

Noncontrolling interest

     (33     

 

  (1) The gross amount due under the receivables we acquired is $1,474 million, of which $141 million is expected to be uncollectable.
  (2) Goodwill will not be deductible for statutory tax purposes and is attributable to Cadbury’s workforce and the significant synergies we expect from the acquisition.
  (3) We acquired $10.3 billion of indefinitely lived intangible assets, primarily trademarks, and $2.6 billion of amortizable intangible assets, primarily customer relationships and technology. Customer relationships will be amortized over approximately 13 years and technology will be amortized over approximately 12 years.
  (4) Within other current liabilities, a reserve for exposures related to taxes of approximately $70 million was established within our Developing Markets segment. The cumulative exposure was approximately $150 million at December 31, 2010.

The above amounts represent the allocation of purchase price which was completed during the fourth quarter of 2010.

Pizza Divestiture:

On March 1, 2010, we completed the sale of the assets of our North American frozen pizza business (“Frozen Pizza”) to Nestlé USA, Inc. (“Nestlé”) for $3.7 billion. Our Frozen Pizza business was a component of our U.S. Convenient Meals and Canada & North America Foodservice segments. The sale included the DiGiorno, Tombstone and Jack’s brands in the U.S., the Delissio brand in Canada and the California Pizza Kitchen trademark license. It also included two Wisconsin manufacturing facilities (Medford and Little Chute) and the leases for the pizza depots and delivery trucks. Approximately 3,600 of our employees transferred with the business to Nestlé. Accordingly, the results of our Frozen Pizza business have been reflected as discontinued operations on the consolidated statement of earnings, and prior period results have been revised in a consistent manner. As a result of the divestiture, we recorded a gain on discontinued operations of $1,596 million, or $0.92 per diluted share, in 2010.

Pursuant to the Frozen Pizza business Transition Services Agreement, we agreed to provide certain sales, co-manufacturing, distribution, information technology, accounting and finance services to Nestlé for up to two years.

Summary results of operations for the Frozen Pizza business through March 1, 2010 were as follows:

 

nnnn2010nnnn nnnn2010nnnn nnnn2010nnnn
     For the Years Ended December 31,  
             2010                     2009                     2008          
     (in millions)  

Net revenues

   $ 335      $ 1,632      $ 1,440   
                        

Earnings before income taxes

     73        341        267   

Provision for income taxes

     (25     (123     (97

Gain on discontinued operations, net of income taxes

     1,596        -        -   
                        

Earnings and gain from discontinued
operations, net of income taxes

   $     1,644      $       218      $       170   
                        

 

22


Earnings before income taxes as presented exclude associated allocated overheads of $25 million in 2010, $108 million in 2009 and $112 million in 2008.

The 2010 gain on discontinued operations from the sale of the Frozen Pizza business included tax expense of $1.2 billion.

The following assets of the Frozen Pizza business were included in the Frozen Pizza divestiture (in millions):

 

Decembern31,2008 Decembern31,2008 Decembern31,2008

Inventories, net

   $ 102         

Property, plant and equipment, net

     317         

Goodwill

     475         
              

Distributed assets of the Frozen Pizza
business

   $ 894         
              

Post Cereals Split-off:

On August 4, 2008, we completed the split-off of the Post cereals business into Ralcorp Holdings, Inc. (“Ralcorp”), after an exchange with our shareholders. Accordingly, the Post cereals business prior period results were reflected as discontinued operations on the consolidated statement of earnings. The exchange was expected to be tax-free to participating shareholders for U.S. federal income tax purposes.

In this split-off transaction, approximately 46 million shares of Kraft Foods Common Stock were tendered for $1,644 million. Our shareholders had the option to exchange some or all of their shares of Kraft Foods Common Stock and receive shares of common stock of Cable Holdco, Inc. (“Cable Holdco”). Cable Holdco was our wholly owned subsidiary that owned certain assets and liabilities of the Post cereals business. In exchange for the contribution of the Post cereals business, Cable Holdco issued approximately $665 million in debt securities, issued shares of its common stock and assumed a $300 million credit facility. Upon closing, we used the cash equivalent net proceeds, approximately $960 million, to repay debt. As a result of the split-off, we recorded a gain on discontinued operations of $926 million, or $0.61 per diluted share, in 2008.

The Post cereals business included such brands as Honey Bunches of Oats, Pebbles, Shredded Wheat, Selects, Grape-Nuts and Honeycomb. Under Kraft Foods, the brands in this transaction were distributed primarily in North America. In addition to the Post brands, the transaction included four manufacturing facilities, certain manufacturing equipment and approximately 1,230 employees who joined Ralcorp as part of the transaction.

Pursuant to the Post cereals business Transition Services Agreement, we provided certain sales, co-manufacturing, distribution, information technology, and accounting and finance services to Ralcorp through 2009.

Summary results of operations for the Post cereals business through August 4, 2008, were as follows:

 

Decembern31,2000 Decembern31,2000 Decembern31,2000
     For the Year Ended
December 31, 2008
              
     (in millions)               

Net revenues

   $ 666        
             

Earnings before income taxes

     189        

Provision for income taxes

     (70     

Gain on discontinued operations, net of
income taxes

     926        
             

Earnings and gain from discontinued
operations, net of income taxes

   $ 1,045        
             

Other Divestitures:

The EU Commission required, as a condition of our Cadbury acquisition, that we divest certain Cadbury confectionery operations in Poland and Romania. In 2010, we completed the sale of the assets of the confectionery operations in Poland and Romania. The total proceeds from the divestitures were $342 million and the impacts of these divestitures were primarily reflected as adjustments to the purchase price allocations.

 

23


In 2009, we received $41 million in net proceeds and recorded pre-tax losses of $6 million on the divestitures of our Balance bar operations in the U.S., a juice operation in Brazil and a plant in Spain. We recorded after-tax gains of $58 million, or $0.04 per diluted share, on these divestitures, primarily due to the differing book and tax bases of our Balance bar operations.

In 2008, we received $153 million in net proceeds, and recorded pre-tax losses of $92 million on divestitures, primarily related to a Nordic and Baltic snacks operation and four operations in Spain. We recorded after-tax losses of $64 million, or $0.04 per diluted share, on these divestitures.

Included in the 2008 divestitures were the following, which were a condition of the EU Commission’s approval of our Groupe Danone S.A. global LU biscuit business (“LU Biscuit”) acquisition:

 

   

We divested a biscuit operation in Spain. From this divestiture, we received $86 million in net proceeds and recorded pre-tax losses of $74 million.

   

We divested another biscuit operation in Spain and a trademark in Hungary that we had previously acquired as part of the LU Biscuit acquisition. As such, the impacts of these divestitures were reflected as adjustments to the purchase price allocations.

The aggregate operating results of the divestitures discussed above, other than the divestiture of the Frozen Pizza and Post cereals businesses, were not material to our financial statements in any of the periods presented. Refer to Note 16, Segment Reporting, for details of the gains and losses on divestitures by segment. The net impacts to segment operating income from gains and losses on divestitures, along with resulting asset impairment charges, are summarized in the table with the Asset Impairment Charges section below.

Asset Impairment Charges

In 2010, we recorded aggregate asset impairment charges of $55 million, or $0.02 per diluted share. During our 2010 review of goodwill and non-amortizable intangible assets, we recorded a $13 million charge for the impairment of intangible assets in the Netherlands and a $30 million charge for the impairment of intangible assets in China. During the fourth quarter of 2010, we also recorded an asset impairment of $12 million on a biscuit plant and related property, plant and equipment in France. We recorded the aggregate asset impairment charges within asset impairment and exit costs.

In 2009, we recorded aggregate asset impairment charges of $21 million, or $0.01 per diluted share. During our 2009 review of goodwill and non-amortizable intangible assets, we recorded a $12 million charge for the impairment of intangible assets in the Netherlands. In addition, during 2009, we recorded a $9 million asset impairment charge to write off an investment in Norway. We recorded the aggregate asset impairment charges within asset impairment and exit costs.

In 2008, we recorded aggregate asset impairment charges of $140 million, or $0.07 per diluted share. During our 2008 review of goodwill and non-amortizable intangible assets, we recorded a $44 million charge for the impairment of intangible assets in the Netherlands, France and Puerto Rico. In addition, in December 2008, we reached a preliminary agreement to divest a juice operation in Brazil and reached an agreement to sell a cheese plant in Australia. In anticipation of divesting the juice operation in Brazil, we recorded an asset impairment charge of $13 million in the fourth quarter of 2008. The charge primarily included the write-off of associated intangible assets of $8 million and property, plant and equipment of $4 million. In anticipation of selling the cheese plant in Australia, we recorded an asset impairment charge of $28 million to property, plant and equipment in the fourth quarter of 2008. Additionally, in 2008, we divested a Nordic and Baltic snacks operation, and incurred an asset impairment charge of $55 million in connection with the divestiture. This charge primarily included the write-off of associated goodwill of $34 million and property, plant and equipment of $16 million. We recorded the aggregate asset impairment charges within asset impairment and exit costs.

 

24


The net impacts to segment operating income from gains and losses on divestitures and the related asset impairment charges recorded when these divestitures were considered held-for-sale are summarized in the table below.

 

     For the Years Ended December 31,  
     2010     2009     2008  
     (in millions)  

Gains / (losses) & asset impairment

    charges on divestitures, net:

                  

Kraft Foods North America:

      

U.S. Beverages

   $ -      $ -      $ (1

U.S. Cheese

     (6     -        -   

U.S. Convenient Meals

     -        -        -   

U.S. Grocery

     -        -        -   

U.S. Snacks

     -        11        -   

Canada & N.A. Foodservice

     -        -        -   

Kraft Foods Europe

     -        (17     (146

Kraft Foods Developing Markets

     -        -        (13
                        
Total net impact from divestitures      $          (6)        $          (6)        $          (160)   
                        

Restructuring Costs

Within our restructuring programs and initiatives, we include certain costs along with exit and disposal costs that are directly attributable to those activities yet they do not qualify for treatment as exit or disposal costs under U.S. GAAP. These costs, which we commonly refer to as other project costs or implementation costs, generally include the integration and reorganization of operations and facilities, the discontinuance of certain product lines and the incremental expenses related to the closure of facilities. Management believes the disclosure and inclusion of these charges provides readers of our financial statements greater transparency to the total costs of our programs and initiatives.

Integration Program:

Our combination with Cadbury has the potential for meaningful synergies and costs savings. We expect to recognize at least $750 million of cost savings by the end of the third year following completion of the acquisition. Additionally, we expect to create revenue synergies from investments in distribution, marketing and product development. In order to achieve these cost savings and synergies, we expect to incur total integration charges of approximately $1.5 billion in the first three years following the acquisition to combine and integrate the two businesses (the “Integration Program”).

Integration Program costs include the costs associated with combining our operations with Cadbury’s and are separate from the costs related to the acquisition. We incurred charges under the Integration Program of $657 million in 2010. We recorded these charges primarily in operations as a part of selling, general and administrative expenses within our Kraft Foods Europe and Kraft Foods Developing Markets segments, as well as general corporate expenses. At December 31, 2010, we had an accrual of $406 million related to the Integration Program.

During the second quarter of 2010, we evaluated Cadbury’s Vision into Action (“VIA”) restructuring program and began managing it within our overall Integration Program. Cadbury initiated the VIA restructuring program in 2007 and planned to run it through 2011. Accordingly, we acquired an accrual of $228 million relating to charges taken in previous periods. In evaluating the program as part of our corporate strategies and our integration plans, we included the remaining charges within our overall Integration Program. As we move forward on a combined company basis, we do not intend to manage these programs separately.

 

25


Cost Savings Initiatives:

Cost savings initiatives generally include exit, disposal and other project costs. We incurred costs associated with our Cost Savings Initiatives of $170 million in 2010, $318 million in 2009, and none in 2008.

 

   

In 2010, we primarily recorded these changes within the segment operating income of Kraft Foods Europe and Canada & N.A. Foodservice. The majority of these charges incurred were for other project costs associated with the Kraft Foods Europe Reorganization.

   

The 2009 charges primarily included severance charges for benefits received by terminated employees, associated benefit plan costs and other related activities. These were recorded in operations, primarily within the segment operating income of Kraft Foods Europe, with the remainder spread across all other segments.

2004-2008 Restructuring Program:

In 2008, we completed our five-year restructuring program (the “Restructuring Program”). The objectives of this program were to leverage our global scale, realign and lower our cost structure, and optimize capacity. As part of the Restructuring Program, we:

 

   

incurred $2.9 billion in pre-tax charges reflecting asset disposals, severance and implementation costs;

   

announced the closure of 35 facilities and announced the elimination of approximately 18,200 positions;

   

will use cash to pay for $1.9 billion of the $2.9 billion in charges; and

   

anticipate reaching cumulative annualized savings of $1.4 billion for the total program.

In 2010, we reversed $37 million of previously accrued Restructuring Program charges, primarily related to severance (resulting in a favorable impact to diluted EPS of $0.01). In 2009, we reversed $85 million of previously accrued Restructuring Program charges (resulting in a favorable impact to diluted EPS of $0.04). The reversals in 2009 related to the following:

 

   

We sold a plant in Spain that we previously announced we would close under our Restructuring Program. Accordingly, we reversed $35 million in Restructuring Program charges, primarily related to severance, and recorded a $17 million loss on the divestiture of the plant in 2009. The reversal occurred in our Kraft Foods Europe segment.

   

We also reversed $50 million of previously accrued Restructuring Program charges in 2009, primarily due to planned position eliminations that did not occur. These were primarily the result of redeployment and natural attrition. The majority of these reversals occurred in our Kraft Foods Europe segment, with the remainder spread across all other segments.

We incurred charges under the Restructuring Program of $989 million in 2008, or $0.45 per diluted share. Since the inception of the Restructuring Program, we have paid cash of $1.8 billion of the $1.9 billion in expected cash payments, including $94 million paid in 2010. At December 31, 2010, we had an accrual of $125 million related to the Restructuring Program, and we anticipate utilizing the majority of it during 2011.

Under the Restructuring Program, we recorded asset impairment and exit costs of $884 million in 2008. We recorded implementation costs of $105 million in 2008.

Provision for Income Taxes

Our effective tax rate was 31.5% in 2010, 28.8% in 2009, and 28.2% in 2008. Our 2010 effective tax rate included net tax benefits of $123 million, primarily due to the favorable resolution of a federal tax audit and the resolution of several items in our international operations, partially offset by a $137 million write-off of deferred tax assets as a result of the U.S. health care legislation enacted in March 2010.

Our 2009 effective tax rate included net tax benefits of $225 million, primarily due to an agreement we reached with the IRS on specific matters related to years 2000 through 2003, settlements with various foreign and state tax authorities, the expiration of the statutes of limitations in various jurisdictions and the divestiture of our Balance bar operations in the U.S.

 

26


Our 2008 effective tax rate included net tax benefits of $222 million from discrete tax events. Of the total net tax benefits, approximately $50 million related to fourth quarter corrections of state, federal and foreign tax liabilities and a third quarter reconciliation of our inventory of deferred tax items that resulted in a write-down of our net deferred tax liabilities. The remaining net tax benefits primarily related to the resolution of various tax audits and the expiration of statutes of limitations in various jurisdictions. Other discrete tax benefits included the impact from divestitures of a Nordic and Baltic snacks operation and several operations in Spain and the tax benefit from impairment charges taken in 2008. In addition, the 2008 tax rate benefited from foreign earnings taxed below the U.S. federal statutory tax rate and from the expected tax benefit of 2008 restructuring expenses. These benefits were only partially offset by state tax expense and certain foreign tax costs.

Consolidated Results of Operations

The following discussion compares our consolidated results of operations for 2010 with 2009, and for 2009 with 2008.

Many factors have an impact on the sales to our customers, including, among others, the timing of holidays and other annual or special events, 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 results as of the last Saturday of the year, and our international operating subsidiaries generally report results two weeks prior to the last Saturday of the year. The results of operations of the newly acquired Cadbury Limited (formerly, Cadbury plc) (“Cadbury”) are reported on the last day of the calendar month. In 2010, we changed the consolidation date for certain European biscuits operations, which are included within our Kraft Foods Europe segment, and certain operations in Asia Pacific and Latin America, which are included within our Kraft Foods Developing Markets segment. Previously, these operations primarily reported period-end results one month or two weeks prior to the end of the period. Now our Kraft Foods Europe segment primarily reports period-end results two weeks prior to the last Saturday of the period, and certain of our operations in Asia Pacific and Latin America report results through the last day of the period.

2010 compared with 2009

 

nn2010nn nn2010nn nn2010nn nn2010nn
    For the Years Ended
December 31,
              
    2010     2009      $ change       % change    
    (in millions, except per
share data; 2009 revised)
              

Net revenues

    $   49,207         $    38,754         $    10,453        27.0%   

Operating income

    5,666        5,183         483               9.3%   

Earnings from continuing operations

    2,495        2,810         (315)        (11.2%)   

Net earnings attributable to Kraft Foods

    4,114        3,021         1,093        36.2%   

Diluted earnings per share from continuing
operations attributable to Kraft Foods

    1.44        1.89         (0.45)        (23.8%)   

Diluted earnings per share attributable to
Kraft Foods

    2.39        2.03         0.36        17.7%   

Net Revenues - Net revenues increased $10,453 million (27.0%) to $49,207 million in 2010, and organic net revenues (1) increased $1,430 million (3.7%) to $40,075 million as follows.

 

Change in net revenues (by percentage point)

    

Higher net pricing

     1.1pp     

Favorable volume/mix

     2.6pp     
            

Total change in organic net revenues (1)

     3.7%     

Cadbury Acquisition

     23.7pp     

Unfavorable foreign currency

     (0.1)pp     

Impact of divestitures

     (0.3)pp     
            

Total change in net revenues

           27.0%     
            

 

(1)    Please see the Non-GAAP Financial Measures section at the end of this Item.

       

 

 

27


The increase in net revenues was primarily driven by the Cadbury acquisition, which added $9,143 million in net revenues during the year. The increase was partially offset by the impact of divestitures and unfavorable foreign currency, due primarily to the impacts of the highly inflationary Venezuelan economy and the strength of the U.S. dollar against the euro, partially offset by the strength of the Canadian dollar, Brazilian real, Australian dollar and Russian ruble against the U.S. dollar. Additionally, increased organic net revenues were driven by favorable volume/mix and higher net pricing. Favorable volume/mix was driven by higher base business shipments across all reportable business segments, except U.S. Cheese and U.S. Grocery. Higher net pricing was reflected across all reportable business segments, except Kraft Foods Europe and U.S. Snacks, as we increased pricing to offset higher input costs.

Operating Income - Operating income increased $483 million (9.3%) to $5,666 million in 2010, due to the following:

 

(percentageipoint) (percentageipoint)
     Operating
Income
    Change  
     (in millions)     (percentage point)  

Operating Income for the Year Ended December 31, 2009
(as revised)

   $  5,183     

Change in operating income

    

Higher input costs

     (487     (8.6)pp   

Higher pricing

     412        7.4pp   

Favorable volume/mix

     495        8.9pp   

Increased operating income from the Cadbury acquisition

     1,139        21.8pp   

Higher acquisition-related costs associated with Cadbury

     (233     (4.3)pp   

Integration Program costs

     (646     (12.5)pp   

Higher net asset impairment and exit costs

     (82     (1.7)pp   

Lower other selling, general and administrative expense

     25        1.0pp   

Change in unrealized losses on hedging activities

     (136     (2.4)pp   

Unfavorable foreign currency

     (8     (0.1)pp   

Other, net

     4        (0.2)pp   
                

Total change in operating income

     483            9.3%   
                

Operating Income for the Year Ended December 31, 2010

   $ 5,666     
          

Input cost increases outpaced pricing during the year. Higher raw material costs more than offset lower manufacturing costs and higher pricing was driven by the increased input costs we experienced during the year. The favorable volume/mix was driven primarily by strong contributions from Kraft Foods Developing Markets, Kraft Foods Europe, U.S. Beverages and U.S. Convenient Meals, partially offset by declines in U.S. Grocery, U.S. Cheese and U.S. Snacks. The Cadbury acquisition, net of Integration Program and higher acquisition-related costs, increased operating income by $260 million. Total selling, general and administrative expenses, as recorded in the condensed consolidated statement of earnings, increased $3,217 million from 2009, but excluding the impacts of divestitures, foreign currency and our Cadbury acquisition (including Integration Program and acquisition-related costs), decreased $25 million versus the prior year. We recognized gains of $67 million in unrealized hedging positions in 2010, versus gains of $203 million in 2009. During 2010, we reversed $37 million in Restructuring Program charges recorded in prior years, versus a reversal of $85 million in Restructuring Program charges recorded in prior years during 2009. We recorded asset impairment charges of $55 million in 2010 related to intangible assets in China and the Netherlands and on a biscuit plant and related property, plant and equipment in France, versus asset impairment charges of $21 million related to intangible assets in the Netherlands and to write off an investment in Norway that were recorded in 2009. In addition, unfavorable foreign currency decreased operating income by $8 million, due primarily to the impacts of the highly inflationary Venezuelan economy and the strength of the U.S. dollar against the euro, partially offset by the strength of the Canadian dollar, Brazilian real, Korean won and Australian dollar against the U.S. dollar.

As a result of these changes, operating income margin decreased from 13.4% in 2009 to 11.5% in 2010.

 

28


Net Earnings and Earnings per Share Attributable to Kraft Foods - Net earnings attributable to Kraft Foods of $4,114 million increased by $1,093 million (36.2%) in 2010. Diluted EPS from continuing operations attributable to Kraft Foods were $1.44 in 2010, down 23.8% from $1.89 in 2009. Diluted EPS attributable to Kraft Foods were $2.39 in 2010, up 17.7% from $2.03 in 2009, due to the following:

 

00000000
     Diluted EPS  

Diluted EPS Attributable to Kraft Foods for the Year
Ended December 31, 2009 (as revised)

   $       2.03   

Discontinued operations

     0.14   
        

Diluted EPS Attributable to Kraft Foods from Continuing
Operations for the Year Ended December 31, 2009 (as revised)

     1.89   

Acquisition-related costs

     0.04   
        

Operating EPS (1) for the Year Ended
December 31, 2009

     1.93   
        

Increases in operations

     0.22   

Increases in operations from the Cadbury acquisition

     0.45   

Change in unrealized gains on hedging activities

     (0.06

Higher net asset impairments and exit costs

     (0.04

Lower gains on divestitures

     (0.04

Change in foreign currency

     -   

Higher interest and other expense, net (2)

     (0.25

Changes in taxes (3)

     0.05   

Higher shares outstanding

     (0.24
        

Operating EPS (1) for the Year Ended December 31, 2010

     2.02   
        

Acquisition-related costs

     (0.12

Acquisition-related interest and other expense, net

     (0.09

Integration Program costs

     (0.29

U.S. health care legislation impact on deferred taxes

     (0.08
        

Diluted EPS Attributable to Kraft Foods from Continuing
Operations for the Year Ended December 31, 2010

     1.44   

2010 gain on the divestiture of our Frozen Pizza business

     0.92   

Discontinued operations

     0.03   
        

Diluted EPS Attributable to Kraft Foods for the Year
Ended December 31, 2010

   $ 2.39   
        

 

  (1) Please see the Non-GAAP Financial Measures section at the end of this Item.
  (2) Excludes impacts of acquisition-related interest and other expense, net.
  (3) Excludes the impacts of the 2010 U.S. health care legislation on deferred taxes and includes the impacts of the U.S. federal tax audit agreements in both 2010 and 2009.

2009 compared with 2008

 

$38,754 $38,754 $38,754 $38,754
     For the Years Ended
December  31,
              
     2009      2008          $ change             % change      
    

(in millions, except per

share data; as revised)

              

Net revenues

   $ 38,754       $ 40,492       $ (1,738      (4.3%

Operating income

     5,183         3,576         1,607        44.9%   

Earnings from continuing operations

     2,810         1,678         1,132        67.5%   

Net earnings attributable to Kraft Foods

     3,021         2,884         137        4.8%   

Diluted earnings per share from continuing
operations attributable to Kraft Foods

     1.89         1.10         0.79        71.8%   

Diluted earnings per share attributable
to Kraft Foods

     2.03         1.90         0.13        6.8%   

 

29


Net Revenues - Net revenues decreased $1,738 million (4.3%) to $38,754 million in 2009, and organic net revenues (1) increased $428 million (1.1%) to $40,565 million as follows.

 

OperatingiIncome OperatingiIncome

Change in net revenues (by percentage point)

     

Higher net pricing

        2.0pp   

Unfavorable volume/mix

        (0.8)pp   

2008 favorable resolution of a Brazilian value added tax claim

        (0.1)pp   
           

Total change in organic net revenues (1)

        1.1%   

Unfavorable foreign currency

        (4.7)pp   

Impact of divestitures

        (0.7)pp   
           

Total change in net revenues

                        (4.3)%   
           

 

(1)    Please see the Non-GAAP Financial Measures section at the end of this item.

       

The decrease in net revenues was primarily driven by unfavorable foreign currency of $1,884 million, due primarily to the strength of the U.S. dollar against the euro, Russian ruble, Ukrainian hryvnia, Canadian dollar, pound sterling, Brazilian real and Polish zloty. The impact of divestitures also had an unfavorable impact on net revenues. The decrease in net revenues was partially offset by higher organic net revenues. The increase in organic net revenues was primarily driven by higher net pricing, partially offset by a decrease in volume/mix and the absence of the 2008 favorable resolution of a Brazilian value added tax claim.

Operating Income - Operating income increased $1,607 million (44.9%) to $5,183 million in 2009, due to the following:

 

Operatingnincome Operatingnincome
     Operating Income     Change  
     (in millions)     (percentage point)  

Operating Income for the Year Ended December 31, 2008     
(as revised)

   $               3,576     

Change in operating income

    

Higher pricing

     811                      16.5pp   

Favorable volume/mix

     83        1.7pp   

Lower input costs

     23        0.1pp   

Lower Restructuring Program costs

     1,074        34.2pp   

Change in unrealized gains on hedging activities

     408        8.3pp   

Lower losses on divestitures, net

     86        3.7pp   

Lower asset impairment charges

     119        3.3pp   

Lower charges from certain legal matters

     22        1.6pp   

2008 favorable resolution of Brazilian value added tax claim

     (67     (1.4)pp   

Acquisition-related costs associated with Cadbury

     (40     (1.2)pp   

Higher other selling, general and administrative expense

     (569     (11.9)pp   

Unfavorable foreign currency

     (325     (9.2)pp   

Other, net

     (18     (0.8)pp   
                

Total change in operating income

     1,607        44.9%   
                

Operating Income for the Year Ended December 31, 2009
(as revised)

   $               5,183     
          

Higher pricing reflected the carryover impact of 2008 pricing actions, as we recovered some of our cumulative cost increases from prior years. The favorable volume/mix was driven by strong contributions from Kraft Foods Developing Markets and U.S. Beverages. The decrease in input costs was driven by lower raw material costs, partially offset by higher manufacturing costs. During 2009, we reversed $85 million in Restructuring Program charges recorded in the prior year, versus the $989 million in Restructuring Program charges recognized in 2008. We recognized gains of $203 million on the change in unrealized hedging positions in 2009, versus losses of $205 million in 2008. We recorded $6 million of net losses on divestitures in 2009, versus $92 million of net losses on divestitures in 2008. We recorded asset impairment charges of $21 million related to intangible assets in the Netherlands and to write off an investment in Norway in 2009, versus asset impairment charges of $140 million related to certain international intangible assets, the divestiture of our Nordic and Baltic snacks operation, a juice operation in Brazil and a cheese plant in Australia that were recorded in 2008. We had $22 million of lower charges from certain legal

 

30


matters. During 2009, we recorded an additional $50 million of charges for legal matters related to certain of our European operations. In 2008, we recorded $72 million in charges for legal matters related to certain of our U.S. and European operations, including U.S. coffee operations. Total selling, general and administrative expenses, as recorded in the consolidated statement of earnings, increased $171 million from 2008. Excluding the impacts of divestitures, foreign currency, charges for certain legal matters, acquisition-related costs associated with Cadbury and prior year Restructuring Program costs it increased $569 million over 2008, primarily due to further investments in our brands, including spending on Cost Savings Initiatives, and higher marketing support costs. In addition, unfavorable foreign currency decreased operating income by $325 million, due primarily to the strength of the U.S. dollar against the pound sterling, euro, Canadian dollar, Russian ruble, Ukrainian hryvnia, Korean won, Brazilian real, and Polish zloty.

As a result of these changes, operating income margin also increased from 8.8% in 2008 to 13.4% in 2009.

Net Earnings and Earnings per Share Attributable to Kraft Foods - Net earnings attributable to Kraft Foods of $3,021 million increased by $137 million (4.8%) in 2009. Diluted EPS from continuing operations attributable to Kraft Foods were $1.89 in 2009, up 71.8% from $1.10 in 2008. Diluted EPS attributable to Kraft Foods were $2.03 in 2009, up 6.8% from $1.90 in 2008, due to the following:

 

0000000000
     Diluted EPS  

Diluted EPS Attributable to Kraft Foods for the Year
Ended December 31, 2008 (as revised)

   $ 1.90   

Discontinued operations

     0.80   
        

Diluted EPS Attributable to Kraft Foods from Continuing Operations
for the Year Ended December 31, 2008 (as revised)

     1.10   

Acquisition-related costs

     -   
        

Operating EPS (1) for the Year Ended
December 31, 2008

     1.10   
        

Increases in operations

     0.13   

Lower charges from certain legal matters

     0.01   

Lower Restructuring Program costs

     0.49   

Change in unrealized gains on hedging activities

     0.18   

Lower asset impairment charges

     0.06   

Lower losses on divestitures, net

     0.08   

2008 favorable resolution of Brazilian value added tax claim

     (0.03

Unfavorable foreign currency

     (0.14

Lower interest and other expense, net (2)

     0.02   

Changes in taxes (3)

     (0.01

Higher shares outstanding

     0.04   
        

Operating EPS (1) for the Year Ended December 31, 2009

     1.93   
        

Acquisition-related costs

     (0.02

Acquisition-related interest and other expense, net

     (0.02
        

Diluted EPS Attributable to Kraft Foods from Continuing Operations
for the Year Ended December 31, 2009

     1.89   

Discontinued operations

     0.14   
        

Diluted EPS Attributable to Kraft Foods for the Year Ended
December 31, 2009 (as revised)

   $ 2.03   
        

 

(1)    Please see the Non-GAAP Financial Measures section at the end of this Item.

(2)    Excludes impacts of acquisition-related interest and other expense, net.

(3)    Includes the impact of the 2009 U.S. federal tax audit agreement.

       

       

       

Results of Operations by Business Segment

We manage and report operating results through three geographic units, Kraft Foods North America, Kraft Foods Europe and Kraft Foods Developing Markets. We manage the operations of Kraft Foods North America and Kraft Foods Europe by product category, and we manage the operations of Kraft Foods Developing Markets by location. Our reportable segments are U.S. Beverages, U.S. Cheese, U.S. Convenient Meals, U.S. Grocery, U.S. Snacks,

 

31


Canada & N.A. Foodservice, Kraft Foods Europe and Kraft Foods Developing Markets. The results of operations from our Cadbury acquisition (including Integration Program and acquisition-related costs), are reflected within our U.S. Snacks, Canada & N.A. Foodservice, Kraft Foods Europe and Kraft Foods Developing Markets segments.

The following discussion compares our results of operations for each of our reportable segments for 2010 with 2009, and for 2009 with 2008.

 

         For the Years Ended December 31,          
         2010     2009     2008          
         (in millions; 2009 & 2008 revised)          
 

Net revenues:

          
 

Kraft Foods North America:

          
 

U.S. Beverages

   $ 3,212      $ 3,057      $ 3,001       
 

U.S. Cheese

     3,528        3,605        4,007       
 

U.S. Convenient Meals

     3,131        3,029        2,947       
 

U.S. Grocery

     3,398        3,453        3,389       
 

U.S. Snacks

     6,001        4,964        5,025       
 

Canada & N.A. Foodservice

     4,696        3,922        4,147       
 

Kraft Foods Europe

     11,628        8,768        9,728       
 

Kraft Foods Developing Markets

     13,613        7,956        8,248       
                              
 

Net revenues

   $ 49,207      $ 38,754      $ 40,492       
                              
         For the Years Ended December 31,          
         2010     2009     2008          
         (in millions; 2009 & 2008 revised)          
 

Operating income:

          
 

Kraft Foods North America:

          
 

U.S. Beverages

   $             564      $             511      $             381       
 

U.S. Cheese

     598        667        563       
 

U.S. Convenient Meals

     268        234        125       
 

U.S. Grocery

     1,164        1,146        1,009       
 

U.S. Snacks

     845        723        638       
 

Canada & N.A. Foodservice

     582        462        395       
 

Kraft Foods Europe

     1,115        785        182       
 

Kraft Foods Developing Markets

     1,577        936        815       
 

Unrealized gains / (losses) on
hedging activities

     67        203        (205    
 

Certain U.S. pension plan costs

     (179     (165     -       
 

General corporate expenses

     (724     (293     (304    
 

Amortization of intangibles

     (211     (26     (23    
                              
 

Operating income

   $ 5,666      $ 5,183      $ 3,576       
                              

As discussed in Note 16, Segment Reporting, management uses segment operating income to evaluate segment performance and allocate resources. We believe it is appropriate to disclose this measure to help investors analyze segment performance and trends. Segment operating income excludes unrealized gains and losses on hedging activities (which are a component of cost of sales), certain components of our U.S. pension plan cost (which are a component of cost of sales and selling, general and administrative expenses), general corporate expenses (which are a component of selling, general and administrative expenses) and amortization of intangibles for all periods presented. We exclude the unrealized gains and losses on hedging activities from segment operating income in order to provide better transparency of our segment operating results. Once realized, the gains and losses on hedging activities are recorded within segment operating results. We exclude certain components of our U.S. pension plan cost from segment operating income because we centrally manage pension plan funding decisions and the determination of discount rate, expected rate of return on plan assets and other actuarial assumptions. Therefore, we allocate only the service cost component of our U.S. pension plan expense to segment operating income.

In 2010, the change in unrealized gains on hedging activities of $67 million primarily resulted from gains associated with commodity hedging activities. In 2009, the change in unrealized gains on hedging activities of $203 million primarily resulted from the 2008 unrealized losses on energy derivatives becoming realized in 2009 and therefore,

 

32


included in segment operating income. In 2008, the change in unrealized losses on hedging activities of $205 million primarily related to energy derivatives, including heating oil (used primarily to hedge transportation costs) and natural gas contracts.

The 2010 increase in general corporate expenses was primarily due to acquisition-related transaction fees, Integration Program costs and the impact of Cadbury’s corporate charges. We incurred acquisition-related transaction fees of $218 million in 2010 and $40 million in 2009. We recorded these charges in operations as part of general corporate expenses. In 2009, general corporate expenses included $50 million of charges for legal matters related to certain of our European operations. In 2008 we recorded $72 million in charges for legal matters related to certain of our U.S. and European operations, including U.S. coffee operations and represented the primary reason general corporate expenses increased $101 million in 2008.

U.S. Beverages

00000000 00000000 00000000 00000000
     For the Years Ended
December 31,
               
     2010      2009      $ change      % change  
     (in millions)                

Net revenues

   $   3,212       $   3,057       $ 155         5.1%   

Segment operating income

     564         511         53         10.4%   
     For the Years Ended
December 31,
               
     2009      2008      $ change      % change  
     (in millions)                

Net revenues

   $ 3,057       $ 3,001       $ 56         1.9%   

Segment operating income

     511         381         130         34.1%   

2010 compared with 2009:

Net revenues increased $155 million (5.1%), due to favorable volume/mix (4.5 pp) and higher net pricing (0.6 pp). The favorable volume/mix impact on net revenue was primarily driven by higher shipments in ready-to-drink beverages, reflecting volume gains in Kool-Aid and Capri Sun; coffee, reflecting volume gains in Maxwell House, Starbucks and Tassimo; and powdered beverages, reflecting volume gains in Tang.

Segment operating income increased $53 million (10.4%), due to favorable volume/mix, lower manufacturing costs, higher net pricing and lower other selling, general and administrative expenses, partially offset by higher raw material costs and higher marketing support costs.

2009 compared with 2008:

Net revenues increased $56 million (1.9%), due to favorable volume/mix (1.3 pp) and higher net pricing (0.6 pp). Favorable volume/mix was driven by higher shipments in ready-to-drink and powdered beverages. Ready-to-drink beverages grew from successful quality and marketing investments in Capri Sun, partially offset by the discontinuation of less profitable ready-to-drink product lines. Powdered beverages volume increased primarily due to strong gains in Kool-Aid and Tang. These favorable factors were partially offset by unfavorable mix driven by the higher ready-to-drink volume. In addition, coffee volume declined primarily driven by lower shipments of Gevalia, partially offset by higher shipments in Maxwell House, Starbucks and Tassimo. Higher net pricing was primarily related to ready-to-drink beverages, partially offset by lower input cost-driven pricing in coffee.

Segment operating income increased $130 million (34.1%), due primarily to lower costs due to the completion of the Restructuring Program, lower raw material costs, higher net pricing, favorable volume/mix (higher shipments, net of unfavorable product mix), lower manufacturing costs and lower other selling, general and administrative expenses, partially offset by higher marketing support costs.

 

33


U.S. Cheese

00000000 00000000 00000000 00000000
    For the Years Ended
December 31,
             
    2010     2009     $ change     % change  
    (in millions)              

Net revenues

  $         3,528      $         3,605      $             (77     (2.1%

Segment operating income

    598        667                    (69     (10.3%
    For the Years Ended
December 31,
             
    2009     2008     $ change     % change  
    (in millions)              

Net revenues

  $ 3,605      $ 4,007      $ (402     (10.0%

Segment operating income

    667        563        104        18.5%   

2010 compared with 2009:

Net revenues decreased $77 million (2.1%), due to unfavorable volume/mix (4.7 pp) and the impact of divestitures (0.4 pp), partially offset by higher net pricing (3.0 pp). Unfavorable volume/mix was driven by lower shipments across most cheese categories. Higher net pricing, across all cheese categories, was due to input cost-driven pricing, partially offset by increased promotional spending.

Segment operating income decreased $69 million (10.3%), due to higher raw material costs (primarily higher dairy costs), unfavorable volume/mix, higher marketing support costs and a loss on the divestiture of our Bagelfuls operations, partially offset by higher net pricing, lower manufacturing costs, lower other selling, general and administrative expenses and the impact of divestitures.

2009 compared with 2008:

Net revenues decreased $402 million (10.0%), due to lower net pricing (8.8 pp) and unfavorable volume/mix (1.2 pp). Lower net pricing was due to lower input cost-driven pricing combined with increases in promotional spending. Net revenues also declined due to lower shipments, primarily in cultured and natural cheese products.

Segment operating income increased $104 million (18.5%), due primarily to lower raw material costs (primarily lower dairy costs), lower manufacturing costs, lower costs due to the completion of the Restructuring Program and lower other selling, general and administrative expenses, partially offset by lower net pricing and higher marketing support costs.

U.S. Convenient Meals

00000000 00000000 00000000 00000000
    For the Years Ended
December 31,
             
    2010     2009     $ change     % change  
    (in millions; 2009 revised)              

Net revenues

  $         3,131      $         3,029      $         102        3.4%   

Segment operating income

    268        234        34        14.5%   
    For the Years Ended
December 31,
             
    2009     2008     $ change     % change  
    (in millions; as revised)              

Net revenues

  $ 3,029      $ 2,947      $ 82        2.8%   

Segment operating income

    234        125        109        87.2%   

2010 compared with 2009:

Net revenues increased $102 million (3.4%), due to favorable volume/mix (3.1 pp) and higher net pricing (0.3 pp). Favorable volume/mix was driven by higher shipments in hot dogs, Lunchables combination meals and cold cuts. Higher net pricing was driven by input-cost driven pricing, mostly offset by increased promotional spending.

Segment operating income increased $34 million (14.5%), due to lower other selling, general and administrative expenses, lower manufacturing costs, favorable volume/mix and higher net pricing, partially offset by higher raw material costs and higher marketing support costs.

 

34


2009 compared with 2008:

Net revenues increased $82 million (2.8%), due to higher net pricing (2.8 pp). Higher net pricing was driven by input cost-driven pricing, net of increased promotional spending. Volume/mix was flat as higher shipments in bacon, cold cuts and hot dogs were offset by the discontinuation of less profitable product lines.

Segment operating income increased $109 million (87.2%), due primarily to higher net pricing, lower costs due to the completion of the Restructuring Program and favorable volume/mix, partially offset by higher other selling, general and administrative expenses and higher marketing support costs.

U.S. Grocery

00000000 00000000 00000000 00000000
    For the Years Ended
December 31,
             
    2010     2009     $ change     % change  
    (in millions)              

Net revenues

  $ 3,398      $ 3,453      $ (55     (1.6%

Segment operating income

    1,164        1,146        18        1.6%   
    For the Years Ended
December 31,
             
    2009     2008     $ change     % change  
    (in millions)              

Net revenues

  $ 3,453      $ 3,389      $ 64        1.9%   

Segment operating income

    1,146        1,009        137        13.6%   

2010 compared with 2009:

Net revenues decreased $55 million (1.6%), due to unfavorable volume/mix (3.3 pp), partially offset by higher net pricing (1.7 pp). Unfavorable volume/mix was due primarily to lower shipments across most key categories, including pourable dressings, ready-to-eat desserts, spoonable dressings and dry packaged desserts. Higher net pricing, across key categories, was primarily related to Kraft macaroni and cheese dinners, pourable dressings, ready-to-eat desserts and dry packaged desserts.

Segment operating income increased $18 million (1.6%), due primarily to higher net pricing, lower manufacturing costs and lower other selling, general and administrative expenses, partially offset by unfavorable volume/mix and higher marketing support costs.

2009 compared with 2008:

Net revenues increased $64 million (1.9%), due to higher net pricing (3.5 pp), partially offset by unfavorable volume/mix (1.6 pp). Net revenues increased due to higher input cost-driven pricing across several of our key categories, primarily spoonable salad dressings, dry packaged desserts and ready-to-eat desserts. Net revenues growth was partially offset by lower volume, net of favorable product mix. This reflected the 2008 exit of Handi-Snacks ready-to-eat desserts, as well as lower shipments in pourable and spoonable salad dressings, Jell-O ready-to-eat-desserts, barbecue sauce and Cool Whip whipped topping, which were partially offset by growth in Kraft macaroni and cheese dinners.

Segment operating income increased $137 million (13.6%), due primarily to higher net pricing, lower costs due to the completion of the Restructuring Program and lower manufacturing costs, partially offset by higher marketing support costs, unfavorable volume/mix (lower shipments, net of improved product mix) and higher other selling, general and administrative expenses.

U.S. Snacks

00000000 00000000 00000000 00000000
    For the Years Ended
December 31,
             
    2010     2009     $ change     % change  
    (in millions)              

Net revenues

  $ 6,001      $ 4,964      $ 1,037        20.9%   

Segment operating income

    845        723        122        16.9%   
    For the Years Ended December
31,
             
    2009     2008     $ change     % change  
    (in millions)              

Net revenues

  $ 4,964      $ 5,025      $ (61     (1.2%

Segment operating income

    723        638        85        13.3%   

 

35


2010 compared with 2009:

Net revenues increased $1,037 million (20.9%), due to our Cadbury acquisition (21.7 pp) and favorable volume/mix (0.5 pp), partially offset by the impact of divestitures (1.1 pp) and lower net pricing (0.2 pp). Biscuits net revenues decreased, driven by unfavorable volume/mix, partially offset by higher net pricing. Biscuits unfavorable volume/mix was due primarily to lower shipments in crackers (primarily Wheat Thins, Cheese Nips, Premium and Honey Maid) and cookies (primarily Newtons and Nutter Butter). Snack nuts net revenues increased, due to favorable volume/mix, driven by higher shipments.

Segment operating income increased $122 million (16.9%), due primarily to our Cadbury acquisition (including Integration Program and acquisition-related costs), the favorable resolution of a settlement relating to the 2009 pistachio product recall, lower manufacturing costs and lower other selling, general and administrative expenses. These favorable variances were partially offset by higher raw material costs, higher marketing support costs, unfavorable volume/mix, the 2009 gain on the divestiture of our Balance bar operations in the U.S., the impact of divestitures and lower net pricing.

2009 compared with 2008:

Net revenues decreased $61 million (1.2%), due to unfavorable volume/mix (1.7 pp) and the impact of divestitures (0.2 pp), partially offset by higher net pricing (0.7 pp). Biscuits net revenues increased, driven by higher input cost-driven pricing, partially offset by unfavorable volume/mix (unfavorable product mix, net of higher shipments). Biscuits volume gain was due to higher shipments primarily in Ritz crackers, Oreo cookies, Triscuit crackers and Chips Ahoy! cookies. Snack bars net revenues decreased, primarily due to volume declines in breakfast bars. Snack nuts net revenues decreased, primarily driven by lower net pricing, due to higher promotional spending, and unfavorable volume/mix reflecting lower volume due primarily to the recall of certain products containing pistachios in March 2009.

Segment operating income increased $85 million (13.3%), due primarily to lower costs due to the completion of the Restructuring Program, lower marketing support costs, lower manufacturing costs, higher net pricing, the gain on the divestiture of our Balance bar operations in the U.S. and lower other selling, general and administrative expenses. These favorable factors were partially offset by higher raw material costs and unfavorable volume/mix (unfavorable product mix and lower shipments, including the recall of certain products containing pistachios).

Canada & N.A. Foodservice

00000000 00000000 00000000 00000000
    For the Years Ended
December 31,
             
    2010     2009     $ change     % change  
    (in millions; 2009 revised)              

Net revenues

  $ 4,696      $ 3,922      $ 774        19.7%   

Segment operating income

    582        462        120        26.0%   
    For the Years Ended
December 31,
             
    2009     2008     $ change     % change  
    (in millions; as revised)              

Net revenues

  $ 3,922      $ 4,147      $ (225     (5.4%

Segment operating income

    462        395        67        17.0%   

2010 compared with 2009:

Net revenues increased $774 million (19.7%), due to our Cadbury acquisition (11.1 pp), the significant impact of favorable foreign currency (6.4 pp) and higher net pricing (1.5 pp) and favorable volume/mix (0.8 pp). In Canada, net revenues increased, driven by our Cadbury acquisition, favorable foreign currency, higher net pricing and favorable volume/mix, driven by higher shipments in its grocery, cheese and convenient meals retail businesses. In N.A. Foodservice, net revenues increased, driven by higher net pricing and favorable foreign currency, partially offset by unfavorable volume/mix (unfavorable product mix, net of higher shipments).

Segment operating income increased $120 million (26.0%), due primarily to our Cadbury acquisition(including Integration Program and acquisition-related costs), higher net pricing, favorable foreign currency, lower manufacturing costs, favorable volume/mix and lower marketing support costs, partially offset by higher raw material costs and higher other selling, general and administrative expenses.

 

36


2009 compared with 2008:

Net revenues decreased $225 million (5.4%), due to the significant impact of unfavorable foreign currency (4.5 pp) and unfavorable volume/mix (1.0 pp), partially offset by higher net pricing (0.1 pp). In Canada, net revenues increased, driven by volume gains across most retail businesses and higher net pricing, partially offset by unfavorable foreign currency. In N.A. Foodservice, net revenues decreased, driven by lower volume, due to industry-wide declines in restaurant traffic and the discontinuation of less profitable product lines, lower input cost-driven pricing and unfavorable foreign currency.

Segment operating income increased $67 million (17.0%), due primarily to lower costs due to the completion of the Restructuring Program, lower raw material costs and higher net pricing, partially offset by unfavorable foreign currency, higher manufacturing costs, unfavorable volume/mix and higher marketing support costs.

Kraft Foods Europe

00000000 00000000 00000000 00000000
     For the Years Ended
December 31,
              
     2010      2009      $ change     % change  
     (in millions)               

Net revenues

   $ 11,628       $ 8,768       $ 2,860        32.6%   

Segment operating income

     1,115         785         330        42.0%   
     For the Years Ended
December 31,
              
     2009      2008      $ change     % change  
     (in millions)               

Net revenues

   $ 8,768       $ 9,728       $ (960     (9.9%)   

Segment operating income

     785         182         603        100+%   

2010 compared with 2009:

Net revenues increased $2,860 million (32.6%), due to our Cadbury acquisition (33.0 pp) and favorable volume/mix (3.9 pp; including approximately 0.6 pp from the favorable impact of an accounting calendar change for certain European biscuits operations), partially offset by the impact of unfavorable foreign currency (3.1 pp), lower net pricing (1.0 pp), and the impact of divestitures (0.2 pp). Volume/mix gains in biscuits, chocolate, cheese and coffee, due primarily to higher shipments, drove net revenues higher. Lower net pricing was reflected across all categories, except coffee. Unfavorable foreign currency primarily reflected the strength of the U.S. dollar against the euro, partially offset by the strength of the Swedish krona, Swiss franc, and Norwegian krone versus the U.S. dollar.

Segment operating income increased $330 million (42.0%), due primarily to favorable volume/mix, lower manufacturing costs, lower other selling, general and administrative expenses, our Cadbury acquisition (including Integration Program and acquisition-related costs), the 2009 asset impairment charges related to certain intangible assets in the Netherlands and to write-off an investment in Norway, the 2009 loss on the divestiture of a plant in Spain and lower marketing support costs. These favorable variances were partially offset by higher raw material costs, lower net pricing, lower reversal of prior years’ Restructuring Program costs, asset impairment charges related to intangible assets in the Netherlands and on a biscuit plant and related property, plant and equipment in France, and unfavorable foreign currency. The accounting calendar change for certain European biscuits operations had an insignificant impact on operating income.

2009 compared with 2008:

Net revenues decreased $960 million (9.9%), due to the significant impact of unfavorable foreign currency (6.7 pp), unfavorable volume/mix (2.8 pp) and the impact of divestitures (2.2 pp), partially offset by higher net pricing (1.8 pp). Unfavorable foreign currency primarily reflected the strength of the U.S. dollar versus the euro and pound sterling. In addition, volume declines in coffee, biscuits, chocolate and cheese and the discontinuation of less profitable product lines drove net revenues lower. These unfavorable revenue drivers were partially offset by higher net pricing, primarily in chocolate, coffee and biscuits.

Segment operating income increased $603 million (100+%), due primarily to lower costs due to the completion of the Restructuring Program (including the reversal of prior year costs), higher net pricing, the 2008 net loss on the divestitures of several operations in Spain, 2008 asset impairment charges related to certain international intangible assets and the divestiture of our Nordic and Baltic snacks operation, lower manufacturing costs and lower raw material costs. These favorable variances were partially offset by unfavorable foreign currency, higher marketing

 

37


support costs, higher non-recurring costs associated with the Kraft Foods Europe Reorganization, higher other selling, general and administrative expenses (primarily spending on Cost Savings Initiatives), asset impairment charges related to certain intangible assets in the Netherlands and to write off an investment in Norway, the net loss on the divestiture of a plant in Spain, unfavorable volume/mix (lower shipments, net of improved product mix) and the impact of divestitures.

Kraft Foods Europe Reorganization - The reorganization of our European operations to function on a pan-European centralized category management and value chain model was completed in 2009 for our chocolate, coffee and cheese categories. The integration of our European biscuits business was principally completed in the second quarter of 2010. Our subsidiary, Kraft Foods Europe GmbH, acts as the European Principal Company (“EPC”). The EPC manages our European categories centrally and makes decisions for all aspects of the value chain, except for sales and distribution. Our European subsidiaries will execute sales and distribution locally, and the local production companies act as toll manufacturers on behalf of the EPC. As part of the reorganization, we incurred $21 million of severance costs and $69 million of other project costs during 2010; $32 million of severance costs and $81 million of other project costs during 2009; and we incurred $16 million of restructuring costs, $39 million of implementation costs and $11 million of other non-recurring costs during 2008. In 2010 and 2009, these charges were recorded within cost of sales and selling, general and administrative expenses The 2008 restructuring and implementation costs were included in the total Restructuring Program charges, and the other non-recurring costs were recorded as selling, general and administrative expenses. Management believes the disclosure of other project costs and other non-recurring costs provides readers of our financial statements greater transparency to the total costs of our Kraft Foods Europe Reorganization.

Kraft Foods Developing Markets

00000000 00000000 00000000 00000000
     For the Years Ended
December 31,
              
     2010      2009      $ change     % change  
     (in millions)               

Net revenues

   $ 13,613       $ 7,956       $ 5,657        71.1%   

Segment operating income

     1,577         936         641        68.5%   
     For the Years Ended December
31,
              
     2009      2008      $ change     % change  
     (in millions)               

Net revenues

   $ 7,956       $ 8,248       $ (292     (3.5%)   

Segment operating income

     936         815         121        14.8%   

2010 compared with 2009:

Net revenues increased $5,657 million (71.1%), due to our Cadbury acquisition (59.8 pp), favorable volume/mix (8.5 pp; including approximately 1.9 pp from the favorable impact of an accounting calendar change for Asia Pacific and certain operations in Latin America), and higher net pricing (3.3 pp), partially offset by the impact of divestitures (0.3 pp) and the impact of unfavorable foreign currency (0.2 pp). In Central and Eastern Europe, Middle East and Africa, net revenues increased, driven by our Cadbury acquisition, favorable volume/mix across most of the region and favorable foreign currency. In Latin America, net revenues increased, driven by our Cadbury acquisition, higher net pricing across most of the region and favorable volume/mix, primarily in Brazil, Argentina, Central America and Mexico, partially offset by unfavorable foreign currency and the impact of divestitures. In Asia Pacific, net revenues increased, due primarily to our Cadbury acquisition, favorable volume/mix driven by higher shipments across the region, primarily in China, Indonesia and Australia/New Zealand, and favorable foreign currency.

Segment operating income increased $641 million (68.5%), due to our Cadbury acquisition (including Integration Program and acquisition-related costs), favorable volume/mix, higher net pricing and lower other selling, general and administrative expenses. These favorable variances were partially offset by higher marketing support costs, higher manufacturing costs, higher raw material costs, asset impairment charges related to intangible assets in China and unfavorable foreign currency. The accounting calendar change for Asia Pacific and certain operations in Latin America had an insignificant impact on operating income.

2009 compared with 2008:

Net revenues decreased $292 million (3.5%), due to the significant impact of unfavorable foreign currency (12.9 pp), the absence of the 2008 favorable resolution of a Brazilian value added tax claim (0.8 pp) and the impact of divestitures (0.5 pp), partially offset by higher net pricing (8.9 pp) and favorable volume/mix (1.8 pp). In Central and

 

38


Eastern Europe, Middle East and Africa, net revenues decreased, driven primarily by unfavorable foreign currency, partially offset by higher net pricing across most of the region and favorable volume/mix (improved product mix, net of lower shipments). In Latin America, net revenues increased, primarily driven by higher net pricing across the region and favorable volume/mix (improved product mix, net of lower shipments), partially offset by unfavorable foreign currency and the absence of the 2008 favorable resolution of a Brazilian value added tax claim. In Asia Pacific, net revenues increased, due to higher net pricing across most of the region and favorable volume/mix (improved product mix, net of lower shipments), primarily in China, partially offset by unfavorable foreign currency.

Segment operating income increased $121 million (14.8%), due primarily to higher net pricing, favorable volume/mix (improved product mix, net of lower shipments), lower costs due to the completion of the Restructuring Program (including the reversal of prior year costs) and 2008 asset impairment charges related to certain international intangible assets, a juice operation in Brazil and a cheese plant in Australia. These favorable variances were partially offset by higher raw material costs, higher manufacturing costs, unfavorable foreign currency, higher other selling, general and administrative expenses, higher marketing support costs and the absence of the 2008 favorable resolution of a Brazilian value added tax claim.

Venezuela - In the fourth quarter of 2009, the Venezuelan economy was classified as highly inflationary under accounting principles generally accepted in the United States of America (“U.S. GAAP”). Effective January 1, 2010, we began accounting for our Venezuelan subsidiaries under highly inflationary accounting rules, which principally means all transactions are recorded in U.S. dollars. On January 8, 2010, the Venezuelan government devalued its currency and established a preferential exchange rate for imports of food, medicine and other essential items. Accordingly, we were required to revalue our net assets in Venezuela. In July 2010, the Venezuelan government eliminated the secondary (or parallel) market exchange rate and replaced it with the government-regulated Transaction System for Foreign Currency Denominate Securities (“SITME”) rate. Accordingly, we were required to revalue those of our net assets in Venezuela that we maintained at the parallel rate. Then on December 30, 2010, the Venezuelan government eliminated the preferential exchange rate. Although the elimination of the preferential exchange rate did not immediately cause us to revalue our net assets in Venezuela, it will have further impacts to our operating results in future periods. Venezuela now has two exchange rates: the official rate and the SITME rate. We used both the official rate and the SITME rate to translate our Venezuelan operations into U.S. dollars, based on the nature of the operations of each individual subsidiary.

During 2010, we recorded approximately $115 million of unfavorable foreign currency impacts relating to highly inflationary accounting in Venezuela. This included a one-time impact to translate cash of $34 million that we previously carried at the secondary rate. Upon the change to highly inflationary accounting in January 2010, we were required to translate those U.S. dollars on hand using the official rate. Based on the current economic structure in Venezuela, we expect our 2011 operating results will be negatively impacted by approximately another $25 to $50 million as a result of the change to highly inflationary accounting and the devaluation of the Venezuelan bolivar.

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 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.

Principles of Consolidation:

The consolidated financial statements include Kraft Foods, as well as our wholly owned and majority owned subsidiaries. Our domestic operating subsidiaries report results as of the last Saturday of the year, and our international operating subsidiaries generally report results two weeks prior to the last Saturday of the year. The results of operations of the newly acquired Cadbury are reported on the last day of the calendar month.

In 2010, we changed the consolidation date for certain European biscuits operations, which are included within our Kraft Foods Europe segment, and certain operations in Asia Pacific and Latin America, which are included within our Kraft Foods Developing Markets segment. Previously, these operations primarily reported period-end results one month or two weeks prior to the end of the period. Now our Kraft Foods Europe segment primarily reports period-end

 

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results two weeks prior to the last Saturday of the period, and certain of our operations in Asia Pacific and Latin America report results through the last day of the period. We believe the change is preferable and will improve financial reporting by better matching the close dates of the operating subsidiaries within our Kraft Foods Europe segment and those operations with Asia Pacific and Latin America with our consolidated reporting. This change resulted in a favorable impact to net revenues of approximately $200 million and an insignificant impact on operating income and net income in 2010. As the impacts to prior period results were not material to our financial results, we have not revised the prior period results for this change. Our domestic operating subsidiaries will continue to report period-end results as of the Saturday closest to the end of each period, and our international operating subsidiaries will continue to report period-end results two weeks prior to the Saturday closest to the end of each period.

We account for investments in which we exercise significant influence (20% - 50% ownership interest) under the equity method of accounting. We use the cost method of accounting for investments in which we have an ownership interest of less than 20% and in which we do not exercise significant influence. Noncontrolling interest in subsidiaries consists of the equity interest of noncontrolling investors in consolidated subsidiaries of Kraft Foods. All intercompany transactions are eliminated.

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. 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. 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 in which we know the actual amounts. 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. We value all our inventories using the average cost method. 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 for impairment of assets held for use, 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 estimated 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.

Goodwill and Intangible Assets:

We test goodwill and non-amortizable intangible assets at least annually for impairment. We have recognized goodwill in our reporting units, which are generally one level below our operating segments. We use a two step process to test goodwill at the reporting unit level. The first step involves a comparison of the estimated fair value of each reporting unit with its carrying value. Fair value is estimated using discounted cash flows of the reporting unit based on planned growth rates, and estimates of discount rates and residual values. If the carrying value exceeds the fair value, we must proceed with the second step of the process. The second step measures the difference between the carrying value and implied fair value of goodwill. To test non-amortizable intangible assets for impairment, we compare the fair value of the intangible asset with its carrying value. Fair value of non-amortizable intangible assets is determined using our planned growth rates, and estimates of discount rates and royalty rates. 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.

We perform our annual impairment review of goodwill and non-amortizable intangible assets as of October 1 each year. The basis of our valuation methodology for estimating the fair value of our 21 reporting units is a 20-year projection of discounted cash flows that is based on our annual strategic planning process. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, industry and economic conditions. For reporting units within our Kraft Foods North America and Kraft Foods Europe geographic

 

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units, we used a market-participant, weighted-average cost of capital of 7.5% to discount the projected cash flows of those operations. For reporting units within our Kraft Foods Developing Markets geographic unit, we used a risk-rated discount rate of 10.5%.

In 2010, we recorded aggregate asset impairment charges of $55 million, or $0.02 per diluted share. During our 2010 review of goodwill and non-amortizable intangible assets, we recorded a $13 million charge for the impairment of intangible assets in the Netherlands and a $30 million charge for the impairment of intangible assets in China. During the fourth quarter of 2010, we also recorded an asset impairment of $12 million on a biscuit plant and related property, plant and equipment in France. We recorded the aggregate asset impairment charges within asset impairment and exit costs. During our 2010 impairment review, we also noted that the following five reporting units were the most sensitive to near-term changes in our discounted cash flow assumptions:

 

Octoberi1,2010 Octoberi1,2010
     Percentage of
Excess Fair
Value over
Carrying Value
     October 1, 2010
Carrying Value
of Goodwill
 
            (in millions)  

U.S. Confections

     17%       $ 2,177   

U.S. Grain Snacks

     10%         5,778   

U.S. Salty Snacks

     12%         1,170   

Central and Eastern Europe,
Middle East and Africa

     8%         3,390   

Asia Pacific

     18%         2,517   

Each of our reporting units passed the first step of our 2010 annual impairment review with an estimated fair value greater than 105% of its carrying value. Looking past 2010, there are uncertainties within the five identified reporting units that could potentially require further analysis in the future in order for us to determine if a goodwill impairment exists within any of the individual reporting units. Significant uncertainties are:

 

   

Across Kraft Foods North America, and specifically within our U.S. Grain Snacks reporting unit, we experienced significant input cost inflation over the past year. In 2010 the contribution from pricing trailed input cost inflation. Consequently, in 2011 we have announced price increases on selective portions of the portfolio, while also implementing sizing changes on other portions of the portfolio. If input costs continue to rise, as we expect, additional price increases will be required. We expect to take needed pricing actions in the midst of persistent consumer weakness; however, if we are unable to, it would decrease profitability and adversely affect the estimated fair value of our U.S. Grain Snacks reporting unit.

   

Our U.S. Salty Snacks business grew in 2010, after experiencing two years of volume declines. Revenues and operating income grew more substantially as we increased pricing and implemented cost saving measures. Further volume, revenue or operating income declines would adversely affect the estimated fair value of U.S. Salty Snacks reporting unit. However, as noted, we also experienced significant input cost inflation over the past year within our U.S. Salty Snacks business. If input costs continue to rise, as we expect, additional price increases will be required. We expect to take needed pricing actions in the midst of persistent consumer weakness; however, if we are unable to, it would decrease profitability and adversely affect the estimated fair value of our U.S. Salty Snacks reporting unit.

   

Our U.S. Confections, Asia Pacific and Central and Eastern Europe, Middle East and Africa businesses compose a significant portion of our 2010 Cadbury acquisition. As our Cadbury acquisition was only eight months prior to our annual review of goodwill on October 1, 2010, we did not expect a significant amount of excess estimated fair value over book value to be realized in such a short period. We expect to integrate our combined businesses in these reporting units over the next two years; however, if we are unable to, it would adversely affect the estimated fair values of these reporting units.

 

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As part of the 2009 annual review of goodwill and non-amortizable intangible assets, we recorded a $12 million charge for the impairment of intangible assets in the Netherlands. In addition, during 2009 we recorded a $9 million asset impairment charge to write off an investment in Norway. We recorded the aggregate charges within asset impairment and exit costs.

During the fourth quarter of 2008, we completed the annual review of goodwill and non-amortizable intangible assets and recorded a $44 million charge for the impairment of intangible assets in the Netherlands, France and Puerto Rico. In addition, in December 2008, we reached a preliminary agreement to divest a juice operation in Brazil and reached an agreement to sell a cheese plant in Australia. In anticipation of divesting the juice operation in Brazil, we recorded an asset impairment charge of $13 million in the fourth quarter of 2008. The charge primarily included the write-off of associated intangible assets of $8 million and property, plant and equipment of $4 million. In anticipation of selling the cheese plant in Australia, we recorded an asset impairment charge of $28 million to property, plant and equipment in the fourth quarter of 2008. Additionally, in 2008, we divested a Nordic and Baltic snacks operation and incurred an asset impairment charge of $55 million in connection with the divestiture. This charge primarily included the write-off of associated goodwill of $34 million and property, plant and equipment of $16 million. We recorded the aggregate charges within asset impairment and exit costs.

Insurance and 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 health care 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 generally 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 Foods’ shipping and handling costs are classified as part of cost of sales. A provision for product returns and allowances for bad debts are also recorded as reductions to revenues within the same period that the revenue is recognized.

Selling, general and administrative expenses:

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 to 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 recovery of those costs is deemed probable. At December 31, 2010, our subsidiaries were involved in 74 active actions in the U.S. under Superfund legislation (and other similar actions and legislation) 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 countries in which we do business. Outside the U.S., we have specific programs across our business units designed to meet applicable environmental compliance requirements.

As of December 31, 2010, we had accrued an insignificant amount for environmental remediation. 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.

 

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Employee Benefit Plans:

We provide a range of benefits to our employees and retired employees. These include pension benefits, 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 11, Benefit Plans, to the consolidated financial statements for a discussion of the assumptions used.

We recorded the following amounts in earnings for these employee benefit plans during the years ended December 31, 2010, 2009 and 2008:

 

         2010     2009     2008      
               (in millions)            
 

U.S. pension plan cost

   $            322      $             313      $             160     
 

Non-U.S. pension plan cost

     209        77        82     
 

Postretirement health care cost

     234        221        254     
 

Postemployment benefit plan cost

     17        18        11     
 

Employee savings plan cost

     104        94        93     
 

Multiemployer pension plan contributions

     30        29        27     
 

Multiemployer medical plan contributions

     35        35        33     
                            
 

Net expense for employee benefit plans

   $ 951      $ 787      $ 660     
                            

The 2010 net expense for employee benefit plans of $951 million increased by $164 million over the 2009 amount. The cost increase primarily related to higher pension plan costs, including costs associated with the Cadbury acquisition and higher amortization of the net loss from experience differences. The 2009 net expense for employee benefit plans of $787 million increased by $127 million over the 2008 amount. The cost increase primarily related to higher pension plan costs, including higher amortization of the net loss from experience differences and settlement losses for the U.S. pension plans.

In 2010, we contributed $85 million to our U.S. pension plans and $303 million to our non-U.S. pension plans. In addition, employees contributed $23 million to our non-U.S. plans. Based on current tax law, we plan to make contributions of approximately $540 million to our U.S. plans and approximately $400 million to our non-U.S. plans in 2011. Of our total 2011 pension contributions, approximately $510 million will be voluntary. Our actual contributions may differ from our planned contributions due to many factors, including changes in tax and other benefit laws, or significant differences between expected and actual pension asset performance or interest rates. For our U.S. qualified pension plans, we are currently only required to make a nominal cash contribution to our U.S. pension plans under the Pension Protection Act of 2006 in 2011.

We expect our 2011 net expense for employee benefit plans to remain flat, primarily due to a weighted-average decrease of 40 basis points in our U.S. discount rate assumption partially offset by lower forecasted non-U.S. pension plan costs due to plan assumption changes.

We are freezing our U.S. pension plans for current salaried and non-union hourly employees effective December 31, 2019. Pension accruals for all salaried and non-union employees who are currently earning pension benefits will end on December 31, 2019, and continuing pay and service will be used to calculate the pension benefits through December 31, 2019. Our projected benefit obligation decreased $168 million in 2009, and we incurred a $5 million curtailment charge in 2009 related to the freeze. Beginning in 2010, our annual U.S. pension plan costs decreased by approximately $40 million as a result of this change. Additionally, for salaried and non-union hourly employees hired in the U.S. after January 1, 2009, we discontinued benefits under our U.S. pension plans, and we replaced them with an enhanced company contribution to our employee savings plan. This did not have a significant impact on our 2010 or 2009 pension plan cost.

Our 2011 health care cost trend rate assumption increased to 7.50% from 7.00% for our U.S. postretirement plans and decreased to 8.83% from 9.00% for our non-U.S. postretirement plans. We established these rates based upon

 

43


our most recent experience as well as 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 by 2016 and 6.00% for non-U.S. plans by 2017. 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, 2010:

 

(10.4) (10.4)
     One-Percentage-Point  
           Increase                 Decrease       

Effect on total of service and interest cost

     12.7%         (10.4%

Effect on postretirement benefit obligation

     10.5%         (8.8%

Our 2011 discount rate assumption decreased to 5.30% from 5.70% for our U.S. postretirement plans and decreased to 5.02% from 5.25% for our non-U.S. postretirement plans. Our 2011 discount rate decreased to 5.53% from 5.93% for our U.S. pension plans. We model these 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. Our 2011 discount rate assumption for our non-U.S. pension plans decreased to 5.11% from 5.21%. We developed the discount rates for our non-U.S. plans from local bond indices that match local benefit obligations as closely as possible. Changes in our discount rates were primarily the result of changes in bond yields year-over-year.

Our 2011 expected rate of return on plan assets decreased to 7.95% from 8.00% for our U.S. pension plans. We determine our expected rate of return on plan assets from the plan assets’ historical long-term investment performance, current asset allocation and estimates of future long-term returns by asset class. We attempt to maintain our target asset allocation by rebalancing between asset classes as we make contributions and monthly benefit payments.

While we do not anticipate further changes in the 2011 assumptions for our U.S. and non-U.S. pension and postretirement health care plans, as a sensitivity measure, a fifty-basis point change in our discount rate or a fifty-basis point change in the expected rate of return on plan assets would have the following effects, increase / (decrease) in cost, as of December 31, 2010:

 

00000000 00000000 00000000 00000000
     U.S. Plans      Non-U.S. Plans  
     Fifty-Basis-Point      Fifty-Basis-Point  
           Increase                Decrease                 Increase                Decrease       
     (in millions)  

Effect of change in discount rate on
pension costs

   $ (64   $ 66       $ (38   $ 36   

Effect of change in expected rate of return
on plan assets on pension costs

     (31     31         (38     38   

Effect of change in discount rate on
postretirement health care costs

     (12     12         (1     1   

Financial Instruments:

As we operate globally, we use certain financial instruments to manage our foreign currency exchange rate, commodity price and interest rate 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, commodity price and interest rate risk management strategies that seek to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates, commodity prices and interest rates, 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.

 

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By using derivatives to hedge exposures to changes in exchange rates, commodity prices and interest rates, we have 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 with a duration greater than one year 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 we use, 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 a derivative that is highly effective and designated as a cash flow hedge, to the extent that the hedge is effective, are recorded each period in accumulated other comprehensive earnings / (losses). 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. Changes in the fair value of a derivative that is highly effective and designated as a fair value hedge, along with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, are recorded in current period earnings. Cash flows from hedging instruments are classified in the same manner as the affected hedged item in the consolidated statements of cash flows.

We also have numerous investments in our foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. We use foreign-currency-denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates. We designated our euro and pound sterling denominated borrowings as a net investment hedge of a portion of our overall European operations. The gains and losses on our net investment in these designated European operations are economically offset by losses and gains on our euro and pound sterling denominated borrowings. The change in the debt’s fair value is recorded in the currency translation adjustment component of accumulated other comprehensive earnings / (losses).

Income Taxes:

We recognize tax benefits in our financial statements when our uncertain tax positions are 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.

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.

Commodity Trends

We purchase large quantities of commodities, including dairy, coffee, cocoa, wheat, corn products, soybean and vegetable oils, nuts, meat products, and sugar and other sweeteners. In addition, we use significant quantities of plastic, glass 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.

Significant cost items in chocolate confectionery products are cocoa and sugar. We purchase cocoa and sugar on world markets, and the prices are affected by the quality and availability of supply and changes in the value of the pound sterling and the U.S. dollar relative to certain other currencies. Cocoa bean, cocoa butter and sugar costs on average were higher in 2010 than in 2009. We purchase 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 products are substantially influenced by market supply and demand, as well as by government programs. Dairy commodity costs on average were higher in 2010 than in 2009. 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, changes in the value of the U.S. dollar in relation to certain other

 

45


currencies and consumer demand for coffee products. Green coffee bean costs on average were higher in 2010 than in 2009. Significant cost items in our biscuit and grocery products are grains (wheat, corn and soybean oil). Grain costs have experienced significant volatility as a result of burgeoning global demand for food, livestock feed and biofuels such as ethanol and biodiesel. Grain costs on average decreased from 2009 to 2010.

During 2010, our aggregate commodity costs increased primarily as a result of higher cocoa, sugar, dairy, coffee and meat costs, partially offset by lower grain costs. For 2010, our commodity costs were approximately $1.0 billion higher than 2009, following a decrease of approximately $150 million in 2009 compared to 2008. Overall, we expect commodity costs to continue to be volatile and to further increase in 2011.

Liquidity

We believe that our cash from operations, our existing $4.5 billion revolving credit facility (which supports our commercial paper program) and our authorized long-term financing will provide sufficient liquidity to meet our working capital needs, planned capital expenditures, future contractual obligations and payment of our anticipated quarterly dividends. We continue to utilize our commercial paper program and primarily uncommitted international credit lines for regular funding requirements. We also use short-term intercompany loans from foreign subsidiaries to improve financial flexibility. Overall, we do not expect any negative effects to our funding sources that would have a material effect on our liquidity.

Net Cash Provided by Operating Activities:

Operating activities provided net cash of $3.7 billion in 2010, $5.1 billion in 2009, and $4.1 billion in 2008. The decrease in operating cash flows in 2010 primarily related to estimated tax payments on the Frozen Pizza divestiture, increased inventory levels and the unfavorable impact of acquisition-related financing fees, partially offset by increased earnings.

The increase in operating cash flows in 2009 primarily related to working capital improvements over the prior year. The capital improvements were primarily due to improved inventory positions, partially offset by higher interest payments, principally due to the first annual payment on our euro notes. Additionally, higher earnings also attributed to an increase in operating cash flows. The increase in operating cash flows was partially offset by higher pension contributions, driven by total voluntary contributions of $400 million that we made to our U.S. pension plans in May and December 2009.

We anticipate making U.S. pension contributions of approximately $540 million in 2011 and non-U.S. pension contributions of approximately $400 million in 2011. We expect to fund these contributions from operations.

Net Cash Used in Investing Activities:

Net cash used in investing activities was $7.5 billion in 2010, $1.2 billion in 2009, and $1.3 billion in 2008. The increase in cash used in investing activities in 2010 primarily related to the Cadbury acquisition, partially offset by higher proceeds from divestitures. The decrease in cash used in investing activities in 2009 primarily related to a $99 million payment made to Groupe Danone S.A. in 2008 to refund excess cash received in the acquisition of LU Biscuit and lower capital expenditures, partially offset by lower proceeds from divestitures.

During 2010, we paid $9.8 billion in net cash for the Cadbury acquisition, and we received $3.7 billion in proceeds from the sale of the Frozen Pizza business and $0.3 billion in proceeds from the divestitures in Poland and Romania. During 2009, we divested our Balance bar operations in the U.S., a juice operation in Brazil and a plant in Spain and received $41 million in net proceeds. During 2008, we received $153 million in net proceeds on divestitures, primarily related to a Nordic and Baltic snacks operation and four operations in Spain, and we disbursed $56 million for transaction fees related to the split-off of the Post cereals business. Additionally, we paid Groupe Danone S.A. the aforementioned refund in 2008.

Capital expenditures, which were funded by operating activities, were $1.7 billion in 2010, $1.3 billion in 2009, and $1.4 billion in 2008. Cadbury accounted for approximately $440 million of the capital expenditures in 2010. The 2010 capital expenditures were primarily used to modernize manufacturing facilities and support new product and productivity initiatives. We expect 2011 capital expenditures to be approximately $1.8 billion, including capital expenditures required for systems investments and the Integration Program. We expect to fund these expenditures from operations.

 

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Net Cash Provided by / (Used in) Financing Activities:

Net cash provided by financing activities was $4.2 billion in 2010, $3.1 billion used in 2009 and $2.1 billion used in 2008. The net cash provided by financing activities in 2010 primarily related to proceeds from our long-term debt issuance of $9.4 billion, partially offset by $2.2 billion in dividends paid, $2.1 billion in long-term debt repayments, primarily related to our repurchase of $1.5 billion in notes through our tender offer, and $864 million in net repayments of short-term borrowings. The net cash used in financing activities in 2009 primarily related to $1.7 billion in dividend payments, $950 million in repayments of long-term debt and $344 million in net commercial paper repayments. Additionally, other cash used in financing activities in 2009 included $69 million in costs related to our bridge facility agreement dated November 9, 2009 (the “Cadbury Bridge Facility”). The net cash used in financing activities in 2008 primarily related to $5.9 billion in payments made on the bridge facility used to fund our LU Biscuit acquisition, $1.7 billion in dividend payments, $777 million in Common Stock share repurchases and $795 million in repayments of long-term debt securities, primarily related to debt that matured on October 1, 2008, partially offset by $6.9 billion in proceeds from our long-term debt offerings.

In November 2011, $1.1 billion of our long-term debt matures. We expect to fund the repayment by re-financing all or a portion of it with long-term debt or short-term borrowings, and any remaining amounts will be funded by cash from operations.

Borrowing Arrangements:

We maintain a revolving credit facility that we have historically used for general corporate purposes, including for working capital purposes, and to support our commercial paper issuances. Our $4.5 billion three-year senior unsecured revolving credit facility expires in November 2012. No amounts have been drawn on the facility.

The revolving credit facility agreement includes a covenant that we maintain a minimum total shareholders’ equity, excluding accumulated other comprehensive earnings / (losses), of at least $28.6 billion. This threshold was increased by $5.6 billion to $28.6 billion due to the equity we issued as part of our Cadbury acquisition. At December 31, 2010, our total shareholders’ equity, excluding accumulated other comprehensive earnings / (losses), was $39.7 billion. We expect to continue to meet this covenant. The revolving credit agreement also contains customary representations, covenants and events of default. However, 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 $2.4 billion at December 31, 2010. Borrowings on these lines amounted to $267 million at December 31, 2010 and $191 million at December 31, 2009.

Cadbury maintained a three-year, £450 million senior unsecured revolving credit facility that we terminated in 2010.

As part of our Cadbury acquisition, on November 9, 2009, we entered into the Cadbury Bridge Facility. During the first quarter of 2010, we borrowed £807 million under the Cadbury Bridge Facility, and later repaid it ($1,205 million at the time of repayment) with proceeds from the divestiture of our Frozen Pizza business. Upon repayment, the Cadbury Bridge Facility was terminated.

Long-term Debt:

Our total debt was $28.7 billion at December 31, 2010 and $19.0 billion at December 31, 2009. Our debt-to-capitalization ratio was 0.44 at December 31, 2010 and 0.42 at December 31, 2009. At December 31, 2010, the weighted-average term of our outstanding long-term debt was 9.9 years.

On December 29, 2010, we repurchased $900 million principal amount of our 5.625% notes due 2011 and $600 million principal amount of our 6.25% notes due 2012, which were validly tendered pursuant to the cash tender offers we initiated in November 2010. We paid $1,596 million aggregate consideration, including accrued and unpaid interest, for the accepted notes in December 2010.

On December 20, 2010, we repaid £77 million (approximately $119 million) of our long-term debt and on August 11, 2010, we repaid $500 million of our long-term debt. We funded these repayments with cash from operations and short-term borrowings.

 

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On February 8, 2010, we issued $9.5 billion of senior unsecured notes at a weighted-average effective rate of 5.364% and used the net proceeds ($9,379 million) to finance the Cadbury acquisition and for general corporate purposes. The general terms of the $9.5 billion notes are:

 

   

$3.75 billion total principal notes due February 10, 2020 at a fixed, annual interest rate of 5.375%. Interest is payable semiannually beginning August 10, 2010.

   

$3.00 billion total principal notes due February 9, 2040 at a fixed, annual interest rate of 6.500%. Interest is payable semiannually beginning August 9, 2010.

   

$1.75 billion total principal notes due February 9, 2016 at a fixed, annual interest rate of 4.125%. Interest is payable semiannually beginning August 9, 2010.

   

$1.00 billion total principal notes due May 8, 2013 at a fixed, annual interest rate of 2.625%. Interest is payable semiannually beginning November 8, 2010.

In addition, these notes include covenants that restrict our ability to incur debt secured by liens above a certain threshold. We also must offer to purchase these notes at a price equal to 101% of the aggregate principal amount, plus accrued and unpaid interest to the date of repurchase, if both of the following occur:

 

  (i) a “change of control” triggering event, and
  (ii) a downgrade of these notes below an investment grade rating by each of Moody’s Investor Service, Inc., Standard & Poor’s Ratings Services and Fitch, Inc. within a specified period.

We expect to continue to comply with our long-term debt covenants. Refer to Note 7, Debt and Borrowing Arrangements, for further details of these debt offerings.

On September 3, 2009, we redeemed our November 2011, 7% $200 million debenture at par value. Upon redemption, we recorded a loss of $14 million within interest and other expense, net which represented the write-off of the remaining discount. On November 12, 2009, we repaid $750 million in notes. These repayments were primarily financed from commercial paper issuances.

The fair value of the long-term debt we acquired as part of our Cadbury acquisition was $2,437 million at February 2, 2010. The acquired debt has the following terms (including U.S. dollar par amounts):

 

   

£77 million (approximately $123 million) total principal notes due December 20, 2010 at a fixed, annual interest rate of 4.875%.

   

C$150 million (approximately $140 million) Canadian bank loan agreement expiring August 30, 2012 at a variable interest rate. The interest rate at December 31, 2010 was 1.573%.

   

$1.00 billion total principal notes due October 1, 2013 at a fixed, annual interest rate of 5.125%.

   

£300 million (approximately $478 million) total principal notes due December 11, 2014 at a fixed, annual interest rate of 5.375%.

   

£350 million (approximately $558 million) total principal notes due July 18, 2018 at a fixed, annual interest rate of 7.250%.

From time to time we refinance long-term and short-term debt. 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. Our Board of Directors has authorized $12.0 billion in general long-term financing authority. As a well-known seasoned issuer, we plan to file an automatic shelf registration statement on Form S-3 with the SEC shortly after this Annual Report on Form 10-K is filed with the SEC.

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 13, Commitments and Contingencies, we have third-party guarantees primarily covering the long-term obligations of our vendors. As part of those transactions, we guarantee that third parties will make

 

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contractual payments or achieve performance measures. At December 31, 2010, the carrying amount of our third-party guarantees on our consolidated balance sheet and the maximum potential payments under these guarantees was $26 million. Substantially all of these guarantees expire at various times through 2018.

In addition, at December 31, 2010, we were contingently liable for $445 million of guarantees related to our own performance. These include letters of credit related to dairy commodity purchases and guarantees related to the payment of custom duties and taxes, and other letters of credit.

Guarantees do not have, and we do not expect them to have, a material effect on our liquidity.

Aggregate Contractual Obligations:

The following table summarizes our contractual obligations at December 31, 2010.

 

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