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Mondelez International, Inc. 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-12
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Graphic
  7. Graphic
Form 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

(Mark One)   
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   For the quarterly period ended September 30, 2008
   OR
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   For the transition period from                      to                     

Commission file number 1-16483

LOGO

Kraft Foods Inc.

(Exact name of registrant as specified in its charter)

 

Virginia   52-2284372
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

Three Lakes Drive,

Northfield, Illinois

  60093
(Address of principal executive offices)   (Zip Code)

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

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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 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 ¨

(Do not check if a smaller reporting company)

   Smaller reporting company ¨

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

At September 30, 2008, there were 1,469,127,963 shares of the registrant’s common stock outstanding.

 

 

 


KRAFT FOODS INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 

         Page No.
PART I –  

FINANCIAL INFORMATION

  
Item 1.  

Financial Statements (Unaudited)

  
 

Condensed Consolidated Statements of Earnings
for the Three Months and Nine Months Ended
September 30, 2008 and 2007

   1
 

Condensed Consolidated Balance Sheets at
September 30, 2008 and December 31, 2007

   2
 

Condensed Consolidated Statements of Shareholders’ Equity
for the Year Ended December 31, 2007 and the
Nine Months Ended September 30, 2008

   3
 

Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2008 and 2007

   4
 

Notes to Condensed Consolidated Financial Statements

   5
Item 2.  

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

   21
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

   41
Item 4.  

Controls and Procedures

   41
PART II –  

OTHER INFORMATION

  
Item 1.  

Legal Proceedings

   42
Item 1A.  

Risk Factors

   43
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

   43
Item 6.  

Exhibits

   43
Signature    44

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

 

i


PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Statements of Earnings

(in millions of dollars, except per share data)

(Unaudited)

 

     For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,
 
     2008    2007    2008    2007  

Net revenues

   $ 10,462    $ 8,760    $ 31,434    $ 25,991  

Cost of sales

     7,096      5,835      20,813      17,018  
                             

Gross profit

     3,366      2,925      10,621      8,973  

Marketing, administration and research costs

     2,199      1,864      6,689      5,631  

Asset impairment and exit costs

     123      173      306      347  

Losses / (gains) on divestitures, net

     1           93      (20 )

Amortization of intangibles

     7      3      18      9  
                             

Operating income

     1,036      885      3,515      3,006  

Interest and other debt expense, net

     298      165      934      378  
                             

Earnings from continuing operations before income taxes

     738      720      2,581      2,628  

Provision for income taxes

     192      185      818      803  
                             

Earnings from continuing operations

     546      535      1,763      1,825  
                             

Earnings and gain from discontinued operations, net of
income taxes (Note 11)

     852      61      975      180  
                             

Net earnings

   $          1,398    $            596    $          2,738    $          2,005  
                             

Per share data:

           

Basic earnings per share:

           

Continuing operations

   $ 0.37    $ 0.34    $ 1.17    $ 1.15  

Discontinued operations

     0.58      0.04      0.65      0.11  
                             

Net earnings

   $ 0.95    $ 0.38    $ 1.82    $ 1.26  
                             

Diluted earnings per share:

           

Continuing operations

   $ 0.36    $ 0.34    $ 1.16    $ 1.13  

Discontinued operations

     0.57      0.04      0.64      0.12  
                             

Net earnings

   $ 0.93    $ 0.38    $ 1.80    $ 1.25  
                             

Dividends declared

   $ 0.29    $ 0.27    $ 0.83    $ 0.77  
                             

 

See notes to condensed consolidated financial statements.

 

1


Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in millions of dollars)

(Unaudited)

 

     September 30,     December 31,  
     2008     2007  

ASSETS

    

Cash and cash equivalents

   $ 737     $ 567  

Receivables (less allowances of $113 in 2008 and $94 in 2007)

     4,709       5,197  

Inventories:

    

Raw materials

     1,825       1,605  

Finished product

     2,839       2,491  
                

Total inventories, net

     4,664       4,096  

Deferred income taxes

     754       575  

Other current assets

     393       302  
                

Total current assets

     11,257       10,737  

Property, plant and equipment, at cost

     18,903       19,204  

Less accumulated depreciation

     8,265       8,426  
                

Property, plant and equipment, net

     10,638       10,778  

Goodwill

     28,573       31,193  

Intangible assets, net

     13,496       12,200  

Prepaid pension assets

     1,712       1,648  

Other assets

     1,269       1,437  
                

TOTAL ASSETS

   $      66,945     $      67,993  
                

LIABILITIES

    

Short-term borrowings

   $ 1,000     $ 7,385  

Current portion of long-term debt

     719       722  

Accounts payable

     3,439       4,065  

Accrued marketing

     1,751       1,833  

Accrued employment costs

     902       913  

Other current liabilities

     2,484       2,168  
                

Total current liabilities

     10,295       17,086  

Long-term debt

     18,874       12,902  

Deferred income taxes

     5,439       4,876  

Accrued pension costs

     771       810  

Accrued postretirement health care costs

     2,890       2,846  

Other liabilities

     2,275       2,178  
                

TOTAL LIABILITIES

     40,544       40,698  

Contingencies (Note 13)

    

SHAREHOLDERS’ EQUITY

    

Common Stock, no par value
(1,735,000,000 shares issued in 2008 and 2007)

            

Additional paid-in capital

     23,505       23,445  

Retained earnings

     13,623       12,209  

Accumulated other comprehensive losses

     (2,005 )     (1,835 )

Treasury stock, at cost

     (8,722 )     (6,524 )
                

TOTAL SHAREHOLDERS’ EQUITY

     26,401       27,295  
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 66,945     $ 67,993  
                

 

See notes to condensed consolidated financial statements.

 

2


Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Statements of Shareholders’ Equity

(in millions of dollars, except per share data)

(Unaudited)

 

     Common
Stock
   Additional
Paid-in
Capital
     Retained
Earnings
     Accumulated
Other
Comprehensive
(Losses) /

Earnings
     Treasury
Stock
     Total
Shareholders’
Equity
 

Balances at January 1, 2007

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

Comprehensive earnings:

                 

Net earnings

                 2,590                      2,590  

Other comprehensive earnings, net

    of income taxes

                        1,234               1,234  
                       

Total comprehensive earnings *

                    3,824  
                       

Initial adoption of FIN 48

                 213                      213  

Exercise of stock options and issuance
of other stock awards

          33        (79 )             293        247  

Net settlement of employee stock
awards with Altria Group, Inc.

          (179 )                           (179 )

Cash dividends declared
($1.04 per share)

                 (1,643 )                    (1,643 )

Common Stock repurchased

                               (3,687 )      (3,687 )

Other

          (35 )                           (35 )
                                                   

Balances at December 31, 2007

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

Comprehensive earnings:

                 

Net earnings

                 2,738                      2,738  

Other comprehensive losses, net

    of income taxes

                        (170 )             (170 )
                       

Total comprehensive earnings *

                    2,568  
                       

Exercise of stock options and issuance
of other stock awards

          60        (75 )             223        208  

Cash dividends declared
($0.83 per share)

                 (1,249 )                    (1,249 )

Common Stock repurchased

                               (777 )      (777 )

Common Stock tendered (Note 11)

                               (1,644 )      (1,644 )
                                                   

Balances at September 30, 2008

   $    $             23,505      $             13,623      $           (2,005 )    $             (8,722 )    $            26,401  
                                                   

 

* Total comprehensive earnings were $567 million for the quarter ended September 30, 2008, $774 million for the quarter ended September 30, 2007 and $2,578 million for the nine months ended September 30, 2007.

See notes to condensed consolidated financial statements.

 

3


Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in millions of dollars)

(Unaudited)

 

     For the Nine Months Ended  
   September 30,  
     2008     2007  

CASH PROVIDED BY / (USED IN) OPERATING ACTIVITIES

    

Net earnings

   $ 2,738     $ 2,005  

Adjustments to reconcile net earnings to operating cash flows:

    

Depreciation and amortization

     752       662  

Deferred income tax benefit

     (118 )     (214 )

Losses / (gains) on divestitures, net

     93       (20 )

Gain on discontinued operations (Note 11)

     (860 )      

Asset impairment and exit costs, net of cash paid

     167       171  

Change in assets and liabilities, excluding the effects of acquisitions
and divestitures:

    

Receivables, net

     373       96  

Inventories

     (817 )     (739 )

Accounts payable

     (216 )     36  

Amounts due to Altria Group, Inc. and affiliates

           (93 )

Other working capital items

     172       (255 )

Change in pension assets and postretirement liabilities, net

     28       128  

Other

     217       503  
                

Net cash provided by operating activities

     2,529       2,280  
                

CASH PROVIDED BY / (USED IN) INVESTING ACTIVITIES

    

Capital expenditures

     (901 )     (858 )

Acquisitions, net of cash received

     (99 )      

Proceeds from divestitures, net of disbursements

     38       203  

Other

     38       15  
                

Net cash used in investing activities

     (924 )     (640 )
                

CASH PROVIDED BY / (USED IN) FINANCING ACTIVITIES

    

Net (repayment) / issuance of short-term borrowings

     (5,834 )     1,102  

Long-term debt proceeds

     6,477       3,550  

Long-term debt repaid

     (65 )     (1,454 )

Decrease in amounts due to Altria Group, Inc. and affiliates

           (149 )

Repurchase of Common Stock

     (777 )     (3,171 )

Dividends paid

     (1,236 )     (1,214 )

Other

     32       (67 )
                

Net cash used in financing activities

     (1,403 )     (1,403 )
                

Effect of exchange rate changes on cash and cash equivalents

     (32 )     22  
                

Cash and cash equivalents:

    

Increase

     170       259  

Balance at beginning of period

     567       239  
                

Balance at end of period

   $           737     $           498  
                

 

See notes to condensed consolidated financial statements.

 

4


Kraft Foods Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1.  Accounting Policies:

Basis of Presentation:

Our interim condensed consolidated financial statements are unaudited. We prepared the condensed consolidated financial statements following SEC rules for interim reporting. As permitted under those rules, a number of footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America have been condensed or omitted. It is management’s opinion that these financial statements include all normal and recurring adjustments necessary for a fair presentation of our financial position and operating results. Net revenues and net earnings for any interim period are not necessarily indicative of future or annual results.

You should read these statements in conjunction with our consolidated financial statements and related notes in our Form 10-K/A for the year ended December 31, 2007.

Kraft Spin-Off from Altria:

In the first quarter of 2007, Altria Group, Inc. (“Altria”) spun off its entire interest (89.0%) in Kraft on a pro rata basis to Altria stockholders in a tax-free transaction. Effective as of the close of business on March 30, 2007, all Kraft shares owned by Altria were distributed to Altria’s stockholders, and our separation from Altria was completed.

Discontinued Operations:

Effective August 4, 2008, we completed the split-off of the Post cereals business. Beginning in the third quarter of 2008, the results of the Post cereals business were reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results were restated in a consistent manner.

Reclassification:

We reclassified dividends payable, other accrued liabilities and income taxes in the prior year balance sheet from separate line items into other current liabilities to conform with the current year’s presentation. We also reclassified income taxes in the prior year statement of cash flows from a separate line item into other working capital items to conform with the current year’s presentation.

New Accounting Pronouncements:

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, as amended in February 2008 by FASB Staff Position (“FSP”) FAS 157-2, Effective Date of FASB Statement No. 157. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FSP FAS 157-2 defers the effective date of SFAS No. 157 for all nonfinancial assets and liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until January 1, 2009. As such, we partially adopted the provisions of SFAS No. 157 effective January 1, 2008. The partial adoption of this statement did not have a material impact on our financial statements. We expect to adopt the remaining provisions of SFAS No. 157 beginning in 2009. We expect this adoption to impact the way in which we calculate fair value for our annual impairment review of goodwill and non-amortizable intangible assets, and when conditions exist that require us to calculate the fair value of long-lived assets; however, we do not expect this adoption to have a material impact on our financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115. We adopted the provisions of SFAS No. 159 effective January 1, 2008. This statement permits entities to choose to measure many financial instruments and certain other items at fair value and report unrealized gains and losses on these instruments in earnings. The adoption of this statement did not have an impact on our financial statements.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. The provisions, which change the way companies account for business combinations, are effective for Kraft as of January 1, 2009. This statement requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose all information needed by investors to understand the nature and financial effect of the business combination. We do not expect the adoption of this statement to have a material impact on our financial statements.

 

5


In December 2007, the FASB also issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin No. 51, the provisions of which are effective for Kraft as of January 1, 2009. This statement requires an entity to classify noncontrolling interests in subsidiaries as a separate component of equity. Additionally, transactions between an entity and noncontrolling interests are required to be treated as equity transactions. We do not expect the adoption of this statement to have a material impact on our financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. The provisions are effective for Kraft as of January 1, 2009. This statement requires enhanced disclosures about (i) how and why we use derivative instruments, (ii) how we account for derivative instruments and related hedged items under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and (iii) how derivative instruments and related hedged items affect our financial results. We do not expect the adoption of this statement to have a material impact on our financial statements.

In June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. The provisions are effective for Kraft as of January 1, 2009. FSP EITF 03-6-1 considers unvested share-based payment awards with the right to receive nonforfeitable dividends or their equivalents participating securities that should be included in the calculation of EPS under the two-class method. As such, following the adoption of FSP EITF 03-6-1, our restricted and deferred stock awards will be considered participating units in our calculation of EPS. We do not expect the adoption of this statement to have a material impact on our financial statements.

Note 2.  Asset Impairment, Exit and Implementation Costs:

Restructuring Program

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

 

   

incurring approximately $3.0 billion in pre-tax charges reflecting asset disposals, severance and implementation costs;

   

closing approximately 35 facilities and eliminating approximately 16,800 positions; and

   

using cash to pay for approximately $1.9 billion of the $3.0 billion in charges.

We incurred $309 million in charges under the Restructuring Program during the first nine months of 2008. Since the inception of the Restructuring Program, we have incurred $2.4 billion in charges and paid cash for $1.3 billion.

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

We are also in the process of reorganizing our European Union segment to function on a pan-European centralized category management and value chain model. After the reorganization is complete, the European Principal Company (“EPC”) will manage the European Union segment categories centrally and make decisions for all aspects of the value chain, except for sales and distribution. The European subsidiaries will execute sales and distribution locally, and the local production companies will act as toll manufacturers on behalf of the EPC. The EPC legal entity has been incorporated as Kraft Foods Europe GmbH in Zurich, Switzerland. As part of this reorganization, we incurred $27 million of implementation costs and $6 million of non-recurring costs during the nine months ended September 30, 2008. Implementation costs are included in the total Restructuring Program charges. Other costs relating to our European Union segment reorganization are recorded as marketing, administration and research costs. Management believes the disclosure of implementation and other non-recurring charges provides readers of our financial statements greater transparency to the total costs of our European Union segment reorganization.

 

6


 

Restructuring Costs:

Under the Restructuring Program, we recorded asset impairment and exit costs of $68 million during the three months and $251 million during the nine months ended September 30, 2008. We expect to pay cash for approximately $187 million of the charges that we incurred during the first nine months of 2008. We announced the closure of two plants during the first nine months of 2008; since the program began in 2004, we have announced the closure of 32 facilities. In October 2008, we announced the closure of one additional plant.

 

Restructuring liability activity for the nine months ended September 30, 2008 was:

 

         Severance     Asset
Write-downs
    Other     Total      
         (in millions)      
 

Liability balance, January 1, 2008

   $ 154     $     $ 16     $ 170    
 

Charges

     148       52       51       251    
 

Cash (spent) / received

     (141 )     34       (32 )     (139 )  
 

Charges against assets

     (3 )     (81 )           (84 )  
 

Currency

     (7 )     (5 )           (12 )  
                                    
 

Liability balance, September 30, 2008

   $          151     $              –     $            35     $          186    
                                    

 

Severance charges include the cost of benefits received by terminated employees. As of September 30, 2008, we had eliminated approximately 13,800 positions, and we had announced our intent to eliminate an additional 900 positions. Severance charges against assets primarily related to incremental pension costs, which reduce prepaid pension assets. Asset impairment write-downs were caused by plant closings and related activity. Cash received on asset write-downs reflects the net cash proceeds from the sales of assets previously written-down under the Restructuring Program. We incurred other costs related primarily to renegotiation of supplier contract costs, workforce reductions associated with facility closings and termination of leasing agreements.

 

Implementation Costs:

Implementation costs are directly attributable to exit costs; however, they do not qualify for treatment under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These costs primarily include incremental expenses related to the closure of facilities and the reorganization of our European Union segment discussed above. Management believes the disclosure of implementation charges provides readers of our financial statements greater transparency to the total costs of our Restructuring Program. Substantially all implementation costs incurred in the first nine months of 2008 will require cash payments.

 

Implementation costs associated with the Restructuring Program were:

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)     (in millions)      
 

Cost of sales

   $ 6     $ 17     $ 15     $ 47    
 

Marketing, administration and

    research costs

     16       10       43       51    
                                    
 

Total implementation costs

   $ 22     $ 27     $ 58     $ 98    
                                    

 

Asset Impairment Charges

 

In August 2008, we reached an agreement to divest a small Nordic and Baltic snacks operation. The transaction closed in October 2008. We recorded an asset impairment charge of $55 million in the third quarter of 2008 in connection with the divestiture. This charge primarily included the write-off of the associated goodwill of $34 million and property, plant and equipment of $16 million, and was recorded within asset impairment and exit costs on the condensed consolidated statement of earnings.

 

7


Total – Asset Impairment, Exit and Implementation Costs

 

We included the asset impairment, exit and implementation costs discussed above, for the three and nine months ended September 30, 2008 and 2007 in segment operating income as follows:

 

         For the Three Months Ended September 30, 2008
         Restructuring
Costs
    Asset
Impairment
   Total Asset
Impairment
and Exit Costs
    Implementation
Costs
    Total
         (in millions)
 

Kraft North America:

           
 

U.S. Beverages

   $ 25     $    $ 25     $ 2     $ 27
 

U.S. Cheese

     2            2       (2 )    
 

U.S. Convenient Meals

     4            4       3       7
 

U.S. Grocery

     (1 )          (1 )     1      
 

U.S. Snacks (1)

                      1       1
 

Canada & N.A. Foodservice

     9            9       2       11
 

Kraft International:

           
 

European Union

     20       55      75       15       90
 

Developing Markets

     9            9             9
                                       
 

Total

   $ 68     $ 55    $ 123     $ 22     $ 145
                                       
             
         For the Three Months Ended September 30, 2007
         Restructuring
Costs
    Asset
Impairment
   Total Asset
Impairment
and Exit Costs
    Implementation
Costs
    Total
         (in millions, as restated)
 

Kraft North America:

           
 

U.S. Beverages

   $ 3     $ 120    $ 123     $     $ 123
 

U.S. Cheese

     11            11       4       15
 

U.S. Convenient Meals

     5            5       6       11
 

U.S. Grocery

     2            2       1       3
 

U.S. Snacks (1)

     5            5       3       8
 

Canada & N.A. Foodservice

     3            3             3
 

Kraft International:

           
 

European Union

     14            14       10       24
 

Developing Markets

     10            10       3       13
                                       
 

Total

   $                  53     $                120    $                173     $                  27     $                200
                                       

 

8


         For the Nine Months Ended September 30, 2008
                   Total Asset          
         Restructuring    Asset    Impairment    Implementation     
         Costs    Impairment    and Exit Costs    Costs    Total
         (in millions)
 

Kraft North America:

              
 

U.S. Beverages

   $ 40    $    $ 40    $ 3    $ 43
 

U.S. Cheese

     11           11      4      15
 

U.S. Convenient Meals

     12           12      3      15
 

U.S. Grocery

     4           4      3      7
 

U.S. Snacks (1)

     10           10      4      14
 

Canada & N.A. Foodservice

     48           48      2      50
 

Kraft International:

              
 

European Union

     79      55      134      37      171
 

Developing Markets

     47           47      2      49
                                    
  Total    $ 251    $ 55    $ 306    $ 58    $ 364
                                    
                
         For the Nine Months Ended September 30, 2007
         Restructuring
Costs
   Asset
Impairment
   Total Asset
Impairment
and Exit Costs
   Implementation
Costs
   Total
         (in millions, as restated)
 

Kraft North America:

              
 

U.S. Beverages

   $ 9    $ 120    $ 129    $ 4    $ 133
 

U.S. Cheese

     46           46      20      66
 

U.S. Convenient Meals

     14           14      12      26
 

U.S. Grocery

     19           19      5      24
 

U.S. Snacks (1)

     12           12      13      25
 

Canada & N.A. Foodservice

     11           11      2      13
 

Kraft International:

              
 

European Union

     91           91      32      123
 

Developing Markets

     25           25      10      35
                                    
 

Total

   $                227    $                120    $                347    $                  98    $                445
                                    
 

 

(1)    This segment was formerly known as U.S. Snacks & Cereals.

 

Note 3.  Goodwill and Intangible Assets:

 

Goodwill by reportable segment was:

 

         September 30,
2008
   December 31,
2007
              
         (in millions; 2007 restated)               
 

Kraft North America:

              
 

U.S. Beverages

   $ 1,290    $ 1,290         
 

U.S. Cheese

     3,000      3,000         
 

U.S. Convenient Meals

     1,460      1,460         
 

U.S. Grocery

     3,046      3,043         
 

U.S. Snacks

     6,963      8,253         
 

Canada & N.A. Foodservice

     2,337      2,364         
 

Kraft International:

              
 

European Union

     8,267      9,392         
 

Developing Markets

     2,210      2,391         
                        
  Total goodwill    $          28,573    $         31,193         
                        

 

9


Intangible assets were:

 

         September 30, 2008     December 31, 2007     
         Intangible     Accumulated     Intangible    Accumulated     
         Assets, at cost     Amortization     Assets, at cost    Amortization     
         (in millions)     
  Non-amortizable intangible assets    $ 13,298     $     $ 12,065    $   
 

Amortizable intangible assets

     276       78       197      62   
                                  
 

Total intangible assets

   $       13,574     $       78     $       12,262    $              62   
                                  

 

Non-amortizable intangible assets consist substantially of brand names purchased through our acquisitions of Nabisco Holdings Corp., the global LU biscuit business of Groupe Danone S.A. (“LU Biscuit”) and the Spanish and Portuguese operations of United Biscuits. Amortizable intangible assets consist primarily of trademark licenses, customer-related intangibles and non-compete agreements.

 

The movements in goodwill and intangible assets were:

 

         Goodwill     Intangible
Assets, at cost
               
         (in millions)                
                    
 

Balance at December 31, 2007

   $ 31,193     $ 12,262          
 

Changes due to:

            
 

Foreign currency

     (65 )     (13 )        
 

Acquisitions

     (1,190 )     1,361          
 

Divestitures

     (1,272 )     (37 )        
 

Asset impairments

     (34 )     (1 )        
 

Other

     (59 )     2          
                          
 

Balance at September 30, 2008

   $ 28,573     $       13,574          
                          

Significant changes to goodwill and intangible assets during the first nine months of 2008 were:

 

   

Acquisitions – We decreased goodwill by $1,190 million and increased intangible assets by $1,361 million primarily due to refinements of preliminary allocations of purchase price for our acquisition of LU Biscuit. The allocations were based upon appraisals that were finalized in the third quarter of 2008.

   

Divestitures – We reduced goodwill by $1,234 million due to the split-off of our Post cereals business, and we reduced goodwill by $38 million and intangible assets by $37 million due to the divestiture of a small operation in Spain.

   

Asset impairments – We recorded asset impairment charges of $34 million to goodwill and $1 million to intangible assets in connection with the divestiture of a small Nordic and Baltic snacks operation.

   

Other – We reduced goodwill by $59 million primarily related to a reconciliation of our inventory of deferred tax items that also resulted in a write-down of our net deferred tax liabilities.

Amortization expense for intangible assets was $7 million during the three months and $18 million during the nine months ended September 30, 2008. We currently estimate amortization expense for each of the next five years to be approximately $25 million or less, including the impact of our LU Biscuit acquisition.

Note 4.  Debt and Borrowing Arrangements:

Borrowing Arrangements:

At December 31, 2007, we had borrowed €3.76 billion (approximately $5.53 billion) under the 364-day bridge facility agreement we used to acquire LU Biscuit (“LU Biscuit Bridge Facility”). Under the terms of the credit agreement, we were required to repay borrowings with the net cash proceeds from debt offerings having a maturity of greater than one year. As such, we repaid the €3.76 billion (approximately $5.92 billion at the time of repayments) with proceeds from our March 20, 2008 and May 22, 2008 debt issuances discussed below. Upon repayment, this facility was terminated.

 

10


Long-Term Debt:

On March 20, 2008, we issued €2.85 billion (approximately $4.50 billion) of senior unsecured notes, and used the net proceeds (€2.83 billion) to repay a portion of our LU Biscuit Bridge Facility. The general terms of the €2.85 billion notes are:

 

   

€2.00 billion (approximately $3.16 billion) total principal notes due March 20, 2012 at a fixed, annual interest rate of 5.750%. Interest is payable annually beginning March 20, 2009.

   

€850 million (approximately $1.34 billion) total principal notes due March 20, 2015 at a fixed, annual interest rate of 6.250%. Interest is payable annually beginning March 20, 2009.

On May 22, 2008, we issued $2.00 billion of senior unsecured notes, and used the net proceeds ($1.97 billion) for general corporate purposes, including the repayment of borrowings under our LU Biscuit Bridge Facility and other short-term borrowings. The general terms of the $2.00 billion notes are:

 

   

$1.25 billion total principal notes due August 23, 2018 at a fixed, annual interest rate of 6.125%. Interest is payable semiannually beginning February 23, 2009.

   

$750 million total principal notes due January 26, 2039 at a fixed, annual interest rate of 6.875%. Interest is payable semiannually beginning January 26, 2009.

The notes from both issuances discussed above include covenants that restrict our ability to incur debt secured by liens above a certain threshold. We are also required to 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 we experience both of the following:

 

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

At September 30, 2008 and December 31, 2007, our long-term debt consisted of:

 

         2008     2007      
         (in millions)      
 

Notes, 4.00% to 7.55% (average effective rate 6.04%), due through 2039

   $ 15,329     $ 13,392    
 

Euro notes, 5.75% to 6.25% (average effective rate 5.88%), due through 2015

     4,003          
 

7% Debenture (effective rate 11.32%), $200 million face amount, due 2011

     180       175    
 

Other foreign currency obligations

     12       16    
 

Capital leases and other

     69       41    
                    
 

Total long-term debt

     19,593       13,624    
 

Less current portion of long-term debt

     (719 )     (722 )  
                    
 

Long-term debt

   $     18,874     $     12,902    
                    

 

Aggregate maturities of our long-term debt for the years ended September 30, are (in millions):

 

 

2009

   $ 719      
 

2010

     1,259      
 

2011

     209      
 

2012

     6,325      
 

2013

     755      
 

Thereafter

     10,430      

On October 1, 2008, we repaid $700 million in notes. This repayment was primarily financed from commercial paper issuances.

Fair Value:

The aggregate fair value of our total long-term debt, based on quoted prices in active markets for identical liabilities, was $19,062 million at September 30, 2008.

 

11


Note 5.  Income Taxes:

As of January 1, 2008, our unrecognized tax benefits were $850 million. If we had recognized all of these benefits, the net impact on our income tax provision would have been $666 million. There were no material changes due to settlements with tax authorities or the expiration of the statute of limitations during the nine months ended September 30, 2008. As a result, the change in our unrecognized tax benefits during the nine months ended September 30, 2008 was insignificant. We expect that the amount of unrecognized tax benefits will decrease by an insignificant amount during the next 12 months. We include accrued interest and penalties related to uncertain tax positions in our tax provision. As of January 1, 2008, we had $232 million of accrued interest and penalties. The increase in accrued interest and penalties during the nine months ended September 30, 2008 was $34 million.

Note 6.  Accumulated Other Comprehensive Losses:

The components of accumulated other comprehensive losses were:

 

         Currency           Derivatives        
         Translation     Pension and     Accounted for        
         Adjustments     Other Benefits     as Hedges     Total  
         (in millions)  
 

Balances at December 31, 2007

   $ (51 )   $ (1,811 )   $ 27     $ (1,835 )
 

Other comprehensive earnings / (losses),
net of income taxes:

        
 

Currency translation adjustments

     (262 )     44             (218 )
 

Amortization of experience losses and
prior service costs

           73             73  
 

Pension settlement

           26             26  
 

Net actuarial loss arising during period

           (40 )           (40 )
 

Change in fair value of derivatives
accounted for as hedges

                 (11 )     (11 )
                
 

Total other comprehensive losses

           (170 )
                                  
 

Balances at September 30, 2008

   $             (313 )   $         (1,708 )   $                16     $          (2,005 )
                                  

Note 7.  Stock Plans:

Beginning in 2008, we changed our annual and long-term incentive compensation programs to further align them with shareholder returns. Under the annual incentive program, we now grant equity in the form of both restricted stock and stock options. The restricted stock will continue to vest 100% after three years, and the stock options will vest one-third each year over three years. Additionally, we changed our long-term incentive plan from a cash-based program to a share-based program.

In January 2008, we granted 1.4 million shares of stock in connection with our long-term incentive plan. The market value per share was $32.26 on the date of grant, and the shares vest based on varying performance, market and service conditions. The unvested shares have no voting rights and do not pay dividends.

In February 2008, as part of our annual incentive program, we issued 3.4 million shares of restricted and deferred stock to eligible U.S. and non-U.S. employees. Restrictions on these shares lapse in the first quarter of 2011. The market value per restricted or deferred share was $29.49 on the date of grant. Also, as part of our annual incentive program, we granted 13.5 million stock options to eligible U.S. and non-U.S. employees at an exercise price of $29.49. The stock options vest one-third each year, beginning in 2009.

We also issued 0.1 million off-cycle shares of restricted and deferred stock during the first nine months of 2008. The weighted-average market value per restricted or deferred share was $31.16 on the date of grant. In aggregate, we issued 4.9 million restricted and deferred shares during the first nine months of 2008, including those issued as part of our long-term incentive plan. During the first nine months of 2008, 6.2 million shares of restricted and deferred stock vested at a market value of $182.5 million.

 

12


We also granted 0.1 million off-cycle stock options during the first nine months of 2008 at an exercise price of $30.78. In aggregate, we granted 13.6 million stock options during the first nine months of 2008. There were 4.7 million stock options exercised during the first nine months of 2008 with a total intrinsic value of $71.9 million.

Note 8.  Benefit Plans:

We sponsor contributory and noncontributory defined benefit pension plans covering most U.S. employees. We provide pension coverage for certain employees of our non-U.S. subsidiaries through separate plans. Local statutory requirements govern many of these plans. In addition, our U.S. and Canadian subsidiaries provide health care and other benefits to most retired employees. Local government plans generally cover health care benefits for retirees outside the U.S. and Canada.

The benefit obligations of our postretirement plans are measured at December 31 of each year. The plan assets and benefit obligations of our U.S. and Canadian pension plans are also measured at December 31 of each year. All other non-U.S. pension plans have been measured at September 30 of each year. SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, requires us to measure plan assets and benefit obligations as of the balance sheet date beginning with our 2008 year end. Accordingly, we will measure our other non-U.S. pension plans as of our operating subsidiaries year-end close date this year, and have elected to use the “15-month” approach to proportionally allocate the transition adjustment required under SFAS No. 158. We expect this adoption to have an insignificant impact on our financial statements.

Pension Plans

Components of Net Periodic Pension Cost:

Net periodic pension cost consisted of the following for the three and nine months ended September 30, 2008 and 2007:

 

         U.S. Plans     Non-U.S. Plans      
         For the Three Months Ended
September 30,
    For the Three Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)      
 

Service cost

   $ 37     $ 40     $ 23     $ 25    
 

Interest cost

     93       91       56       49    
 

Expected return on plan assets

     (131 )     (131 )     (73 )     (64 )  
 

Amortization:

          
 

Net loss from experience differences

     21       35       7       18    
 

Prior service cost

     2       1       2       2    
 

Other expense

     20       19       1          
                                    
 

Net periodic pension cost

   $            42     $            55     $            16     $            30    
                                    
       U.S. Plans       Non-U.S. Plans    
         For the Nine Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)      
 

Service cost

   $ 112     $ 119     $ 70     $ 73    
 

Interest cost

     279       273       169       142    
 

Expected return on plan assets

     (394 )     (393 )     (219 )     (184 )  
 

Amortization:

          
 

Net loss from experience differences

     64       105       22       50    
 

Prior service cost

     5       4       6       6    
 

Other expense

     41       53       1          
                                    
 

Net periodic pension cost

   $ 107     $ 161     $ 49     $ 87    
                                    

 

Retired employees elected lump-sum payments, resulting in settlement losses of $18 million during the three months and $38 million during the nine months ended September 30, 2008 for the U.S. plans. Additionally, as previously discussed in Note 2, Asset Impairment, Exit and Implementation Costs, we announced several workforce reduction initiatives as part of the Restructuring Program. Employees left Kraft under these initiatives, resulting in settlement losses of $2 million during the three months and $3 million during the nine months ended September 30, 2008 for the U.S. plans. Our non-U.S. plans also incurred a $1 million curtailment charge in the third quarter of 2008 related to the split-off of the Post cereals business. These costs are included in other expense above.

 

13


Employer Contributions:

We make contributions to our U.S. and non-U.S. pension plans, primarily, to the extent that they are tax deductible and do not generate an excise tax liability. During the nine months ended September 30, 2008, we contributed $24 million to our U.S. plans and $118 million to our non-U.S. plans. Based on current tax law, we plan to make further contributions of approximately $18 million to our U.S. plans and approximately $56 million to our non-U.S. plans during the remainder of 2008. However, our actual contributions may be different due to many factors, including changes in tax and other benefit laws, pension asset performance that differs significantly from the expected performance, or significant changes in interest rates.

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following for the three and nine months ended September 30, 2008 and 2007:

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)     (in millions)      
 

Service cost

   $ 11     $ 11     $ 33     $ 35    
 

Interest cost

     46       44       137       132    
 

Amortization:

          
 

Net loss from experience differences

     14       15       42       44    
 

Prior service credit

     (7 )     (7 )     (21 )     (20 )  
                                    
 

Net postretirement health care costs

   $              64     $              63     $            191     $            191    
                                    

 

Postemployment Benefit Plans

 

Net postemployment costs consisted of the following for the three and nine months ended September 30, 2008 and 2007:

            
         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)     (in millions)      
 

Service cost

   $ 1     $ 1     $ 3     $ 3    
 

Interest cost

     2       1       5       4    
 

Amortization of net gains

           (1 )     (1 )     (2 )  
 

Other expense

     22       26       145       85    
                                    
 

Net postemployment costs

   $ 25     $ 27     $ 152     $ 90    
                                    

The postemployment benefit plan cost of workforce reduction initiatives announced under the Restructuring Program was $22 million during the three months and $145 million during the nine months ended September 30, 2008. These costs are included in other expense above.

 

14


Note 9.  Earnings Per Share:

Basic and diluted EPS were calculated using the following:

 

         For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,
    
         2008    2007    2008    2007     
         (in millions, except per share data)     
 

Earnings from continuing operations

   $ 546    $ 535    $ 1,763    $ 1,825   
 

Earnings and gain from discontinued
operations, net of income taxes

     852      61      975      180   
                                
 

Net earnings

   $ 1,398    $ 596    $ 2,738    $ 2,005   
                                
 

Weighted average shares for basic EPS

     1,479      1,557      1,501      1,590   
 

Plus incremental shares from assumed
conversions of stock options and
restricted and deferred stock

     17      19      19      18   
                                
 

Weighted average shares for diluted EPS

     1,496      1,576      1,520      1,608   
                                
 

Basic earnings per share:

              
 

Continuing operations

   $ 0.37    $ 0.34    $ 1.17    $ 1.15   
 

Discontinued operations

     0.58      0.04      0.65      0.11   
                                
 

Net earnings

   $ 0.95    $ 0.38    $ 1.82    $ 1.26   
                                
 

Diluted earnings per share:

              
 

Continuing operations

   $ 0.36    $ 0.34    $ 1.16    $ 1.13   
 

Discontinued operations

     0.57      0.04      0.64    $ 0.12   
                                
 

Net earnings

   $          0.93    $          0.38    $          1.80    $          1.25   
                                

We excluded 0.3 million Kraft stock options for the three months and 0.6 million Kraft stock options for the nine months ended September 30, 2008, from the calculation of weighted average shares for diluted EPS because they were antidilutive. For the three and nine months ended September 30, 2007, we excluded an insignificant number of Kraft stock options from the calculation of weighted average shares for diluted EPS because they were antidilutive.

Note 10.  Acquisitions:

On November 30, 2007, we acquired LU Biscuit for €5.1 billion (approximately $7.6 billion) in cash. The acquisition included 32 manufacturing facilities and approximately 14,000 employees. LU Biscuit contributed net revenues of $808 million for the three months and $2,383 million for the nine months ended September 30, 2008. We acquired assets consisting primarily of goodwill of $4,050 million (which will not be deductible for statutory tax purposes), intangible assets of $3,551 million (substantially all of which are indefinite-lived), receivables of $758 million, property, plant and equipment of $1,057 million and inventories of $204 million, and assumed liabilities consisting primarily of accounts payable and accruals of $1,054 million. These purchase price allocations were based upon appraisals that were finalized in the third quarter of 2008. During the second quarter of 2008, we also repaid Groupe Danone S.A. for excess cash received upon the acquisition of LU Biscuit.

Note 11.  Divestitures:

Discontinued Operations:

On August 4, 2008, we completed the split-off of the Post cereals business, which was in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp Holdings, Inc. (“Ralcorp”) after an exchange to our shareholders. The exchange is expected to be tax-free to participating shareholders for U.S. federal income tax purposes.

In this split-off transaction, approximately 46.1 million shares of Kraft Common Stock were tendered for $1,644 million. Our shareholders had the option to exchange some or all of their shares of Kraft 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.

 

15


On June 25, 2008, Cable Holdco filed a registration statement on Form S-1/S-4/A with the SEC that announced the start of the exchange offer. Approximately 30.5 million shares of Cable Holdco were offered in exchange for Kraft Common Stock at an exchange ratio of 0.6606. The exchange ratio was calculated using the daily volume-weighted average prices of Kraft Common Stock and Ralcorp common stock on the New York Stock Exchange on the last three trading days of the offer, which expired on August 4, 2008. The exchange offer was over-subscribed and as a result, the number of shares of Kraft Common Stock accepted for exchange in the offer was prorated. Following the merger of Cable Holdco and a Ralcorp subsidiary, the Cable Holdco common stock was exchanged for shares of Ralcorp common stock on a one-for-one basis.

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

Beginning in the third quarter of 2008, the results of the Post cereals business were reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results were restated in a consistent manner. Pursuant to the Post cereals business transition services agreement, we agreed to provide sales, co-manufacturing, distribution, information technology, and accounting and finance services to Ralcorp for up to 12 months, with Ralcorp’s option to extend it for an additional six months.

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

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)      
 

Net revenues

   $ 90     $ 294     $ 666     $ 854    
                                    
 

(Loss) / earnings before income taxes

     (12 )     96       184       285    
 

Benefit / (provision) for income taxes

     4       (35 )     (69 )     (105 )  
 

Gain on discontinued operations, net of
income taxes

     860             860          
                                    
 

Earnings and gain from discontinued
operations, net of income taxes

   $           852     $           61     $           975     $           180    
                                    
            
The following assets of the Post cereals business were included in the Post distribution effective August 4, 2008 (in millions):
            
  Inventories    $ 83          
 

Plant, property and equipment, net

     425          
 

Goodwill

     1,234          
 

Other assets

     11          
 

Other liabilities

     (3 )        
                  
 

Distributed assets of the Post cereals business

   $ 1,750          
                  

Other:

In August 2008, we reached an agreement to divest a small Nordic and Baltic snacks operation. The transaction closed in October 2008.

During the first nine months of 2008, we divested two small operations in Spain. From these divestitures, we made $11 million in disbursements and recorded pre-tax losses of $18 million.

 

16


The EU Commission made its approval of our LU Biscuit acquisition conditional upon the following divestitures:

 

   

In the second quarter of 2008, we divested a small operation in Spain. From this divestiture, we received $87 million in proceeds and recorded pre-tax losses of $74 million.

   

In the second quarter of 2008 we divested a small 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.

During the nine months ended September 30, 2008, we recorded a pre-tax loss of $93 million on other divestitures, and the aggregate operating results of these other divestitures were not material to our financial statements in any of the periods presented. In aggregate, we received $38 million in net proceeds from divestitures, which included $38 million of disbursements made for transaction fees related to the split-off of the Post cereals business.

Note 12.  Financial Instruments:

Commodity Hedges:

Kraft is exposed to price risk related to forecasted purchases of certain commodities that we primarily use as raw materials. Accordingly, we use commodity forward contracts as cash flow hedges, primarily for coffee, milk, sugar, cocoa and wheat. Commodity forward contracts generally qualify for the normal purchase exception under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and are, therefore, not subject to its provisions.

We use commodity futures and options to hedge the price of certain commodities, including dairy, coffee, cocoa, wheat, corn products, soybean oils, meat products, sugar, natural gas and heating oil. Some of these derivative instruments are highly effective and qualify for hedge accounting treatment under SFAS No. 133. We also sell commodity futures to unprice future purchase commitments. We occasionally use related futures to cross-hedge a commodity exposure. We are not a party to leveraged derivatives and, by policy, do not use financial instruments for speculative purposes.

For those derivative instruments that qualify for hedge accounting treatment under SFAS No. 133, we defer the effective portion of the unrealized gains and losses on commodity futures and option contracts as a component of accumulated other comprehensive earnings / (losses). We recognize the deferred portion as a component of cost of sales when the related inventory is sold. We expect to transfer unrealized losses of $41 million to earnings during the next 12 months, and recognized an insignificant amount during the three and nine months ended September 30, 2008. We recorded an insignificant amount of ineffectiveness in our condensed consolidated statement of earnings during the three and nine months ended September 30, 2008.

For the derivative instruments that we considered economic hedges but did not designate for hedge accounting treatment under SFAS No. 133, we recognized net losses of approximately $128 million during the three months and net gains of approximately $149 million during the nine months ended September 30, 2008, directly as a component of cost of sales.

As of September 30, 2008, we had hedged forecasted commodity transactions for periods not exceeding the next 18 months.

Foreign Currency Cash Flow Hedges:

We use various financial instruments to mitigate our exposure to changes in exchange rates from third-party and intercompany actual and forecasted transactions. These instruments include forward foreign exchange contracts, foreign currency swaps and foreign currency options. Based on the size and location of our businesses, the primary currencies to which we are exposed include the euro, Swiss franc, British pound and Canadian dollar.

Substantially all of these derivative instruments are highly effective and qualify for hedge accounting treatment under SFAS No. 133. We defer the effective portion of unrealized gains and losses associated with forward, swap and option contracts as a component of accumulated other comprehensive earnings / (losses) until the underlying hedged transactions are reported in our condensed consolidated statement of earnings. We recognize the deferred portion as a component of cost of sales when the related inventory is sold, or as foreign currency translation gain or loss for our hedges of intercompany loans when the payments are made. We expect to transfer unrealized gains of $33 million to earnings during the next 12 months, and recognized an insignificant amount during the three and nine months ended September 30, 2008. We recorded no ineffectiveness in our foreign currency cash flow hedges during the first nine months of 2008 in our condensed consolidated statement of earnings. In October 2008, one of our counterparties, Lehman Brothers Commercial Corporation, filed bankruptcy. As such, we wrote off an insignificant amount of derivatives held with them. This did not have a significant impact on our foreign currency risk management program.

 

17


For the derivative instruments that we consider economic hedges but do not designate for hedge accounting treatment under SFAS No. 133, we recognize gains and losses directly as a component of cost of sales or foreign currency translation loss, depending on the nature of the underlying transaction. For these derivative instruments, we recognized an insignificant amount during the three and nine months ended September 30, 2008 in our condensed consolidated statement of earnings.

As of September 30, 2008, we had hedged forecasted foreign currency transactions for periods not exceeding the next 39 months. Excluding intercompany loans, we had hedged forecasted foreign currency transactions for periods not exceeding the next 15 months.

Impact on Other Comprehensive Losses:

Derivatives accounted for as hedges affected accumulated other comprehensive losses, net of income taxes, as follows:

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
         2008     2007     2008     2007  
         (in millions)     (in millions)  
 

Accumulated gain / (loss) at beginning
of period

   $ 48     $ 28     $ 27     $ (4 )
 

Transfer of realized gains in fair value
to earnings

     (2 )     (4 )     (4 )     (7 )
 

Unrealized (loss) / gain in fair value

     (30 )     7       (7 )     42  
                                  
 

Accumulated gain at September 30

   $                  16     $                  31     $              16     $                  31  
                                  

 

Fair Value:

The fair value (asset / (liability)) of our derivatives at September 30, 2008 was:

 

 

 

           Total
Fair Value
    Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
    Significant
Other Observable
Inputs

(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
 
         (in millions)  
 

Derivatives

   $ (155 )   $ (60 )   $ (95 )   $  

Hedges of Net Investments in Foreign Operations:

We have numerous investments in foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. We designated the euro denominated borrowings used to finance the LU Biscuit acquisition as a net investment hedge of a portion of our overall European operations. The gains and losses in our net investment in these designated European operations are economically offset by losses and gains in our euro denominated borrowings. Our cumulative translation adjustment, which is net of taxes, included gains of $303 million during the three months and $60 million during the nine months ended September 30, 2008 related to the euro denominated borrowings.

Note 13.  Commitments and Contingencies:

Legal Proceedings:

We are defendants in a variety of legal proceedings. Plaintiffs in a few of those cases seek substantial damages. We cannot predict with certainty the results of these proceedings. However, we believe that the final outcome of these proceedings will not materially affect our financial results.

During the third quarter of 2008, we recorded charges of $55 million for legal matters related to certain of our U.S. and European operations, including U.S. coffee operations.

 

18


Third-Party Guarantees:

We have third-party guarantees because of our acquisition, divestiture and construction activities. As part of those transactions, we guarantee that third parties will make contractual payments or achieve performance measures. At September 30, 2008, the maximum potential payments under our third-party guarantees were $43 million, of which $8 million have no specified expiration dates. Substantially all of the remainder expire at various times through 2018. The carrying amounts of these guarantees were $38 million on our condensed consolidated balance sheet at September 30, 2008.

Note 14.  Segment Reporting:

Kraft manufactures and markets packaged food products, including snacks, beverages, cheese, convenient meals and various packaged grocery products. We manage and report operating results through two commercial units, Kraft North America and Kraft International. We manage Kraft North America’s operations by product category, and its reportable segments are U.S. Beverages, U.S. Cheese, U.S. Convenient Meals, U.S. Grocery, U.S. Snacks (formerly known as U.S. Snacks & Cereals) and Canada & North America Foodservice. We manage Kraft International’s operations by geographic location, and its reportable segments are European Union and Developing Markets.

Beginning in the third quarter of 2008, the results of the Post cereals business were reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results were restated in a consistent manner. Refer to our Form 8-K filed with the SEC on September 19, 2008 for additional information reconciling prior period segment results to our restated segment results.

In February 2008, we announced the implementation of our new operating structure. Our new structure reflects our strategy to Rewire the Organization for Growth. Within our new structure, business units now have full P&L accountability and are staffed accordingly. This also ensures that we are putting our resources closer to where decisions are made that affect our consumers and customers. Our corporate and shared service functions continue to streamline their organizations and focus them on core activities that can more efficiently support the goals of the business units. As a result of implementing our new operating structure, we began reporting the results of operations under this new structure in the first quarter of 2008 and restated results from prior periods in a consistent manner. The changes were:

 

   

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

   

Our macaroni and cheese category as well as other dinner products were moved from our U.S. Convenient Meals segment to our U.S. Grocery segment to take advantage of operating synergies.

   

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

On April 11, 2008, we filed a Form 8-K with the SEC related to our new operating structure. Refer to the Form 8-K for additional information reconciling our prior period reportable business segments to our new reportable business segments.

Management uses segment operating income to evaluate segment performance and allocate resources. In the second quarter of 2008, we began excluding 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. Segment operating income excludes unrealized gains and losses on hedging activities (which is a component of cost of sales), general corporate expenses and amortization of intangibles for all periods presented. Management believes it is appropriate to disclose this measure to help investors analyze segment performance and trends. We centrally manage interest and other debt expense and the provision for income taxes. Accordingly, we do not present these items by segment because they are excluded from the segment profitability measure that management reviews.

 

19


Segment data were:

 

         For the Three Months Ended     For the Nine Months Ended      
     September 30,     September 30,      
         2008     2007     2008     2007      
         (in millions; 2007 restated)     (in millions; 2007 restated)      
 

Net revenues:

          
 

Kraft North America:

          
 

U.S. Beverages

   $ 743     $ 712     $ 2,304     $ 2,277    
 

U.S. Cheese

     919       859       2,848       2,623    
 

U.S. Convenient Meals

     1,081       995       3,202       2,967    
 

U.S. Grocery

     802       757       2,506       2,411    
 

U.S. Snacks

     1,274       1,220       3,736       3,581    
 

Canada & N.A. Foodservice

     1,109       1,053       3,279       2,962    
 

Kraft International:

          
 

European Union

     2,725       1,855       8,357       5,444    
 

Developing Markets

     1,809       1,309       5,202       3,726    
                                    
 

Net revenues

   $      10,462     $        8,760     $      31,434     $      25,991    
                                    
         For the Three Months Ended     For the Nine Months Ended      
         September 30,     September 30,      
         2008     2007     2008     2007      
         (in millions; 2007 restated)     (in millions; 2007 restated)      
 

Earnings from continuing operations
before income taxes:

          
 

Operating income:

          
 

Segment operating income:

          
 

Kraft North America:

          
 

U.S. Beverages

   $ 81     $ (12 )   $ 359     $ 258    
 

U.S. Cheese

     179       91       419       323    
 

U.S. Convenient Meals

     91       93       318       313    
 

U.S. Grocery

     233       219       777       742    
 

U.S. Snacks

     170       157       464       467    
 

Canada & N.A. Foodservice

     151       131       387       320    
 

Kraft International:

          
 

European Union

     178       129       511       371    
 

Developing Markets

     216       132       552       354    
 

Unrealized (losses) / gains on
hedging activities

     (141 )     (6 )     (38 )     6    
 

General corporate expenses

     (115 )     (46 )     (216 )     (139 )  
 

Amortization of intangibles

     (7 )     (3 )     (18 )     (9 )  
                                    
 

Operating income

     1,036       885       3,515       3,006    
 

Interest and other debt expense, net

     (298 )     (165 )     (934 )     (378 )  
                                    
 

Earnings from continuing operations
before income taxes

   $ 738     $ 720     $ 2,581     $ 2,628    
                                    

We incurred asset impairment, exit and implementation costs of $145 million during the three months and $364 million during the nine months ended September 30, 2008. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for a breakout of charges by segment.

As discussed in Note 11. Divestitures, during the first nine months of 2008, we recorded pre-tax losses of $93 million on divestitures, primarily relating to several small divested operations in Spain. We primarily included these losses in the segment operating income of the European Union segment.

 

20


Net revenues by consumer sector, which includes the separation of Canada & N.A. Foodservice and Kraft International into sector components, were:

 

         For the Three Months Ended
September 30, 2008
   For the Three Months Ended
September 30, 2007
    
         Kraft North
America
   Kraft
International
   Total    Kraft North
America
   Kraft
International
   Total     
         (in millions)    (in millions)     
 

Snacks

   $ 1,525    $ 2,438    $ 3,963    $ 1,442    $ 1,296    $ 2,738   
 

Beverages

     871      1,235      2,106      839      1,084      1,923   
 

Cheese

     1,298      488      1,786      1,230      436      1,666   
 

Grocery

     748      256      1,004      717      227      944   
 

Convenient Meals

     1,486      117      1,603      1,368      121      1,489   
                                              
 

Total net revenues

   $       5,928    $       4,534    $     10,462    $       5,596    $       3,164    $       8,760   
                                              
         For the Nine Months Ended
September 30, 2008
   For the Nine Months Ended
September 30, 2007
    
         Kraft North
America
   Kraft
International
   Total    Kraft North
America
   Kraft
International
   Total     
         (in millions)    (in millions)     
 

Snacks

   $ 4,414    $ 7,325    $ 11,739    $ 4,147    $ 3,767    $ 7,914   
 

Beverages

     2,688      3,688      6,376      2,648      3,201      5,849   
 

Cheese

     3,999      1,479      5,478      3,648      1,228      4,876   
 

Grocery

     2,450      724      3,174      2,368      637      3,005   
 

Convenient Meals

     4,324      343      4,667      4,010      337      4,347   
                                              
 

Total net revenues

   $ 17,875    $ 13,559    $ 31,434    $ 16,821    $ 9,170    $ 25,991   
                                              

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

Description of the Company

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

Kraft Spin-Off from Altria:

In the first quarter of 2007, Altria Group, Inc. (“Altria”) spun off its entire interest (89.0%) in Kraft on a pro rata basis to Altria stockholders in a tax-free transaction. Effective as of the close of business on March 30, 2007, all Kraft shares owned by Altria were distributed to Altria’s stockholders, and our separation from Altria was completed.

Discontinued Operations:

Effective August 4, 2008, we completed the split-off of the Post cereals business. Beginning in the third quarter of 2008, the results of the Post cereals business were reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results were restated in a consistent manner. Accordingly, historical statements of earnings amounts included in Management’s Discussion and Analysis of Financial Condition and Results of Operations were restated to reflect the discontinued operation.

 

21


Executive Summary

The following executive summary provides significant highlights of the Discussion and Analysis that follows:

 

   

Net revenues in the third quarter of 2008 increased 19.4% to $10.5 billion and increased 20.9% to $31.4 billion in the first nine months of 2008.

 

   

Diluted EPS in the third quarter of 2008 increased 100.0+%, including the results of our discontinued operations, to $0.93 and increased 44.0% to $1.80 in the first nine months of 2008.

 

   

We recorded Restructuring Program charges of $90 million during the three months and $309 million during the nine months ended September 30, 2008.

 

   

On November 30, 2007, we acquired the global LU biscuit business of Groupe Danone S.A. for €5.1 billion (approximately $7.6 billion) in cash. LU Biscuit contributed net revenues of $808 million during the three months and $2,383 million during the nine months ended September 30, 2008.

 

   

On August 4, 2008, we completed the split-off of the Post cereals business, which was in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp Holdings, Inc. after an exchange to our shareholders.

 

   

In March 2008, we issued €2.85 billion (approximately $4.50 billion) of senior unsecured notes, and in May 2008, we issued $2.00 billion of senior unsecured notes. We used the net proceeds (€2.83 billion in March and $1.97 billion in May) for general corporate purposes, including the repayment of borrowings under the bridge facility used to fund our LU Biscuit acquisition and other short-term borrowings.

 

   

During the first nine months of 2008, we repurchased 25.3 million shares of our Common Stock for $777 million under our $5.0 billion share repurchase program, including 4.0 million shares repurchased in the third quarter of 2008 for $127 million. We had $723 million remaining under our share repurchase program at September 30, 2008.

 

22


Discussion and Analysis

Summary of Financial Results

The following table shows the significant changes in our after-tax earnings and diluted EPS from continuing operations between the three months ended September 30, 2008 and 2007, and between the nine months ended September 30, 2008 and 2007 (in millions, except per share data):

 

         For the Three Months Ended     For the Nine Months Ended      
         Earnings from
Continuing
Operations
    Diluted EPS
from Continuing
Operations
    Earnings from
Continuing
Operations
    Diluted EPS
from Continuing
Operations
     
 

September 30, 2007

   $ 535     $ 0.34     $ 1,825     $ 1.13    
 

2008 Losses on divestitures, net

     (1 )           (65 )     (0.04 )  
 

2007 Losses on divestitures, net

                 2          
 

Higher Restructuring Program costs

     (11 )     (0.01 )     (6 )     (0.01 )  
 

Lower asset impairment charges

     3             3          
 

European Union segment reorganization

     (2 )           (6 )        
 

Increased unrealized losses on hedging
activities

     (89 )     (0.06 )     (29 )     (0.02 )  
 

Charges for legal matters

     (35 )     (0.02 )     (35 )     (0.02 )  
 

Increases in operations

     191       0.12       424       0.26    
 

Higher interest expense

     (88 )     (0.06 )     (314 )     (0.20 )  
 

2007 Interest from tax reserve transfers
from Altria

                 (50 )     (0.03 )  
 

Deferred tax reconciliation

     29       0.02       29       0.02    
 

Other changes in taxes

     14       0.01       (15 )     (0.01 )  
 

Fewer shares outstanding

           0.02             0.08    
                                    
 

September 30, 2008

   $                 546     $                0.36     $              1,763     $                1.16    
                                    

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

Acquisitions and Divestitures

LU Biscuit:

On November 30, 2007, we acquired the global LU biscuit business of Groupe Danone S.A. (“LU Biscuit”) for €5.1 billion (approximately $7.6 billion) in cash. The acquisition included 32 manufacturing facilities and approximately 14,000 employees. LU Biscuit contributed net revenues of $808 million during the three months and $2,383 million during the nine months ended September 30, 2008. We acquired assets consisting primarily of goodwill of $4,050 million (which will not be deductible for statutory tax purposes), intangible assets of $3,551 million (substantially all of which are indefinite-lived), receivables of $758 million, property, plant and equipment of $1,057 million and inventories of $204 million, and assumed liabilities consisting primarily of accounts payable and accruals of $1,054 million. These purchase price allocations were based upon appraisals that were finalized in the third quarter of 2008. We used borrowings of €5.1 billion to finance this acquisition. Interest incurred on these borrowings was the primary driver of the increase in interest and other debt expense of $133 million during the three months and $479 million during the nine months ended September 30, 2008 (after considering $77 million in interest income received from Altria in the first quarter of 2007).

Discontinued Operations:

On August 4, 2008, we completed the split-off of the Post cereals business, which was in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp Holdings, Inc. (“Ralcorp”) after an exchange to our shareholders. The exchange is expected to be tax-free to participating shareholders for U.S. federal income tax purposes.

In this split-off transaction, approximately 46.1 million shares of Kraft Common Stock were tendered for $1,644 million. Our shareholders had the option to exchange some or all of their shares of Kraft 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.

 

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On June 25, 2008, Cable Holdco filed a registration statement on Form S-1/S-4/A with the SEC that announced the start of the exchange offer. Approximately 30.5 million shares of Cable Holdco were offered in exchange for Kraft Common Stock at an exchange ratio of 0.6606. The exchange ratio was calculated using the daily volume-weighted average prices of Kraft Common Stock and Ralcorp common stock on the New York Stock Exchange on the last three trading days of the offer, which expired on August 4, 2008. The exchange offer was over-subscribed and as a result, the number of shares of Kraft Common Stock accepted for exchange in the offer was prorated. Following the merger of Cable Holdco and a Ralcorp subsidiary, the Cable Holdco common stock was exchanged for shares of Ralcorp common stock on a one-for-one basis.

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

Beginning in the third quarter of 2008, the results of the Post cereals business were reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results were restated in a consistent manner. Pursuant to the Post cereals business transition services agreement, we agreed to provide sales, co-manufacturing, distribution, information technology, and accounting and finance services to Ralcorp for up to 12 months, with Ralcorp’s option to extend it for an additional six months.

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

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions)      
 

Net revenues

   $ 90     $ 294     $ 666     $ 854    
                                    
 

(Loss) / earnings before income taxes

     (12 )     96       184       285    
 

Benefit / (provision) for income taxes

     4       (35 )     (69 )     (105 )  
 

Gain on discontinued operations, net of
income taxes

     860             860          
                                    
 

Earnings and gain from discontinued
operations, net of income taxes

   $           852     $             61     $           975     $           180    
                                    
            
The following assets of the Post cereals business were included in the Post distribution effective August 4, 2008 (in millions):
            
  Inventories    $ 83          
 

Plant, property and equipment, net

     425          
 

Goodwill

     1,234          
 

Other assets

     11          
 

Other liabilities

     (3 )        
                  
 

Distributed assets of the Post cereals business

   $ 1,750          
                  

Other:

In August 2008, we reached an agreement to divest a small Nordic and Baltic snacks operation. The transaction closed in October 2008.

During the first nine months of 2008, we divested two small operations in Spain. From these divestitures, we made $11 million in disbursements and recorded pre-tax losses of $18 million.

 

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The EU Commission made its approval of our LU Biscuit acquisition conditional upon the following divestitures:

 

   

In the second quarter of 2008, we divested a small operation in Spain. From this divestiture, we received $87 million in proceeds and recorded pre-tax losses of $74 million.

   

In the second quarter of 2008 we divested a small 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.

During the nine months ended September 30, 2008, we recorded a pre-tax loss of $93 million, or $0.04 per diluted share, on other divestitures. In aggregate, we received $38 million in net proceeds from divestitures, which included $38 million of disbursements made for transaction fees related to the split-off of the Post cereals business.

During the second quarter of 2007, we divested sugar confectionery assets in Romania and related trademarks. During the first quarter of 2007, we divested our hot cereal assets and trademarks. In aggregate, we received $203 million in proceeds and recorded pre-tax gains of $20 million on these divestitures. We recorded an after-tax loss of $8 million on the hot cereal assets and trademarks divestiture due to the differing book and tax bases.

The aggregate operating results of the other divestitures discussed above were not material to our financial statements in any of the periods presented.

Restructuring Program

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

 

   

incurring approximately $3.0 billion in pre-tax charges reflecting asset disposals, severance and implementation costs;

   

closing approximately 35 facilities and eliminating approximately 16,800 positions;

   

using cash to pay for approximately $1.9 billion of the $3.0 billion in charges; and

   

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

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

We incurred charges under the Restructuring Program of $90 million, or $0.04 per diluted share, during the three months and $309 million, or $0.14 per diluted share, during the nine months ended September 30, 2008, and $80 million, or $0.03 per diluted share, during the three months and $325 million, or $0.13 per diluted share, during the nine months ended September 30, 2007. Since the inception of the Restructuring Program, we have incurred $2.4 billion in charges and paid cash for $1.3 billion. We announced the closure of two plants during the first nine months of 2008; since the program began in 2004, we have announced the closure of 32 facilities. In October 2008, we announced the closure of one additional plant. Additionally, as of September 30, 2008, we had eliminated approximately 13,800 positions, and we had announced our intent to eliminate an additional 900 positions.

Under the Restructuring Program, we recorded asset impairment and exit costs of $68 million during the three months and $251 million during the nine months ended September 30, 2008, and $53 million during the three months and $227 million during the nine months ended September 30, 2007. We recorded implementation costs of $22 million during the three months and $58 million during the nine months ended September 30, 2008, and $27 million during the three months and $98 million during the nine months ended September 30, 2007. Implementation costs are directly attributable to exit costs; however, they do not qualify for treatment under Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These costs primarily include incremental expenses related to the closure of facilities and the reorganization of our European Union segment discussed below. Management believes the disclosure of implementation charges provides readers of our financial statements greater transparency to the total costs of our Restructuring Program.

 

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In addition, we expect to spend approximately $525 million in capital to implement the Restructuring Program. We have spent $473 million in capital since the inception of the Restructuring Program, including $86 million spent in the first nine months of 2008. Cumulative annualized cost savings resulting from the Restructuring Program were approximately $783 million through 2007. Incremental cost savings totaled approximately $212 million in the first nine months of 2008, resulting in cumulative annualized savings under the Restructuring Program of approximately $995 million to date. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for further details of our Restructuring Program.

European Union Segment Reorganization

We are also in the process of reorganizing our European Union segment to function on a pan-European centralized category management and value chain model. After the reorganization is complete, the European Principal Company (“EPC”) will manage the European Union segment categories centrally and make decisions for all aspects of the value chain, except for sales and distribution. The European subsidiaries will execute sales and distribution locally, and the local production companies will act as toll manufacturers on behalf of the EPC. The EPC legal entity has been incorporated as Kraft Foods Europe GmbH in Zurich, Switzerland. As part of this reorganization, we incurred $27 million of implementation costs and $6 million of non-recurring costs during the nine months ended September 30, 2008. Implementation costs are recorded as part of our overall Restructuring Program. Other costs relating to our European Union segment reorganization are recorded as marketing, administration and research costs. Management believes the disclosure of implementation and other non-recurring charges provides readers of our financial statements greater transparency to the total costs of our European Union segment reorganization.

Asset Impairment Charges

In August 2008, we reached an agreement to divest a small Nordic and Baltic snacks operation. The transaction closed in October 2008. We recorded an asset impairment charge of $55 million, or $0.03 per diluted share, in the third quarter of 2008 in connection with the divestiture. This charge primarily included the write-off of the associated goodwill of $34 million and property, plant and equipment of $16 million, and was recorded within asset impairment and exit costs on the condensed consolidated statement of earnings.

In the fourth quarter of 2007, we divested our flavored water and juice brand assets and related trademarks. In recognition of the anticipated divestiture, we recorded an asset impairment charge of $120 million, or $0.03 per diluted share, in the third quarter of 2007. The charge, which included the write-off of the associated goodwill of $3 million, intangible assets of $70 million and property, plant and equipment of $47 million, was recorded within asset impairment and exit costs on the condensed consolidated statement of earnings.

Provision for Income Taxes

Our effective tax rate was 26.0% in the third quarter of 2008 and 31.7% in the first nine months of 2008. Our effective tax rate included net tax benefits of $41 million in the third quarter of 2008, primarily related to a reconciliation of our inventory of deferred tax items that resulted in a write-down of our net deferred tax liabilities and the impact of a return-to-provision adjustment. For the first nine months of 2008, our effective tax rate included net tax benefits of $120 million, primarily related to the write-down of our net deferred tax liabilities, the resolution of state tax audits, the resolution of outstanding items in our international operations and the tax impact of the divestitures of several small operations in Spain.

Our effective tax rate was 25.7% in the third quarter of 2007 and 30.6% in the first nine months of 2007. Our effective tax rate included net tax benefits of $98 million in the third quarter of 2007, primarily related to the tax consequences of the impairment of our flavored water and juice brand assets and related trademarks and various foreign tax law changes enacted during the quarter. For the first nine months of 2007, the effective tax rate included net tax benefits of $106 million, primarily related to the third quarter impairment and tax law changes plus the second quarter resolution of outstanding items in our international operations and various state jurisdictions, partially offset by tax costs associated with the divestiture of our hot cereal assets and trademarks and interest income from Altria related to the transfer of our federal tax contingencies.

 

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As a result of Kraft’s spin-off from Altria, Altria transferred our federal tax contingencies of $375 million to our balance sheet and related interest income of $77 million, or $0.03 per diluted share, in the first quarter of 2007. Following our spin-off from Altria, we are no longer a member of the Altria consolidated tax return group, and we now file our own federal consolidated income tax returns. We continue to assess opportunities to mitigate the loss of tax benefits as a result of filing separately, and currently estimate the annual amount of lost tax benefits to be in the range of $50 million to $75 million, as compared to 2007.

Consolidated Results of Operations

The following discussion compares our consolidated results of operations for the three months ended September 30, 2008 and 2007, and for the nine months ended September 30, 2008 and 2007.

Many factors have an impact on the timing of sales to our customers. These factors include, among others, the timing of holidays and other annual or special events, seasonality, significant weather conditions, timing of our own or customer incentive programs and pricing actions, customer inventory programs and general economic conditions.

 

         For the Three Months Ended
September 30,
                
         2008    2007    $ change     % change      
         (in millions, except
per share data)
                
 

Net revenues

   $ 10,462    $ 8,760    $ 1,702     19.4%    
 

Operating income

     1,036      885      151     17.1%    
 

Earnings from continuing operations

                 546                  535                    11                 2.1%    
 

Net earnings

     1,398      596      802     100.0+%    
 

Diluted earnings per share

     0.93      0.38      0.55     100.0+%    
         For the Nine Months Ended
September 30,
                
         2008    2007    $ change     % change      
         (in millions, except
per share data)
                
 

Net revenues

   $ 31,434    $ 25,991    $ 5,443     20.9%    
 

Operating income

     3,515      3,006      509     16.9%    
 

Earnings from continuing operations

     1,763      1,825      (62 )   (3.4% )  
 

Net earnings

     2,738      2,005      733     36.6%    
 

Diluted earnings per share

     1.80      1.25      0.55     44.0%    

Three Months Ended September 30:

Net Revenues – Net revenues increased $1,702 million (19.4%), due to the impact of our LU Biscuit acquisition (9.3 pp), higher net pricing (8.1 pp), favorable foreign currency (3.9 pp) and favorable resolution of a Brazilian value added tax claim (0.3 pp), partially offset by lower volume (0.9 pp), the impact of divestitures (0.9 pp) and unfavorable mix (0.4 pp). Foreign currency increased net revenues by $339 million, due primarily to the continuing strength of the euro and Brazilian real against the U.S. dollar. Total volume increased 4.1%, with 5.0 pp due to our LU Biscuit acquisition, net of divestitures. In addition, higher base business shipments in our U.S. Beverages and Canada & N.A. Foodservice segments were more than offset by declines in most of our remaining business segments.

 

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Operating Income – Operating income increased $151 million (17.1%), due primarily to higher pricing ($705 million), a 2007 asset impairment charge related to our flavored water and juice brand assets ($120 million), the impact of our LU Biscuit acquisition ($113 million), lower marketing, administration and research costs ($44 million, including lower marketing support costs) and favorable resolution of a Brazilian value added tax claim ($21 million). Partially offsetting these favorable items were higher input costs ($686 million, primarily higher raw material costs, including unrealized losses on certain commodity hedging activities), an asset impairment charge related to the divestiture of our Nordic and Baltic snacks operation ($55 million), charges for legal matters associated with certain of our U.S. and European operations, including U.S. coffee operations ($55 million), unfavorable volume/mix ($27 million), higher general corporate expenses ($21 million, including higher amortization of intangibles), integration costs associated with our LU Biscuit acquisition ($19 million) and higher Restructuring Program costs ($10 million). Foreign currency increased operating income by $31 million, due primarily to the continuing strength of the Brazilian real and the euro against the U.S. dollar.

Earnings per Share – Net earnings of $1,398 million increased by $802 million (100.0+%) in the third quarter 2008. Diluted earnings per share were $0.93, up 100.0+% from $0.38 in 2007. During the third quarter of 2008:

 

   

we realized $0.53 per diluted share ($791 million after taxes) from increased earnings from discontinued operations including a gain on the split-off of our Post cereals business ($860 million after taxes);

   

we recognized income of $0.12 per diluted share ($289 million before taxes) due to increases in operations (including $0.01 per diluted share of foreign currency movements); we also benefited $0.02 per diluted share from a decrease in shares outstanding; $0.02 per diluted share from a deferred tax reconciliation; and $0.01 per diluted share from decreases in our tax rate; and

   

we incurred $0.06 per diluted share ($133 million before taxes) in higher interest and other debt expense; $0.06 per diluted share ($135 million before taxes) in higher unrealized losses on certain commodity hedging activities; $0.02 per diluted share ($55 million before taxes) in charges for legal matters; and $0.01 per diluted share ($10 million before taxes) in higher Restructuring Program costs.

Nine Months Ended September 30:

Net Revenues – Net revenues increased $5,443 million (20.9%), due to the impact of our LU Biscuit acquisition (9.2 pp), higher net pricing (6.4 pp), favorable foreign currency (5.0 pp), favorable mix (1.4 pp) and favorable resolution of a Brazilian value added tax claim (0.3 pp), partially offset by the impact of divestitures (0.8 pp) and lower volume (0.6 pp). Foreign currency increased net revenues by $1,274 million, due primarily to the continuing strength of the euro, Canadian dollar and Brazilian real against the U.S. dollar. Total volume increased 4.9%, with 5.5 pp due to our LU Biscuit acquisition, net of divestitures. In addition, higher base business shipments in our international, Canada & N.A. Foodservice and U.S. Convenient Meals segments were more than offset by declines in our remaining business segments.

Operating Income – Operating income increased $509 million (16.9%), due primarily to higher pricing ($1,652 million), the impact of our LU Biscuit acquisition ($304 million), favorable mix ($166 million), a 2007 asset impairment charge related to our flavored water and juice brand assets ($120 million), favorable resolution of a Brazilian value added tax claim ($64 million), lower Restructuring Program costs ($16 million) and lower fixed manufacturing costs ($13 million). Partially offsetting these favorable items were higher input costs ($1,521 million, primarily higher raw material costs, including unrealized losses on certain commodity hedging activities), losses on 2008 divestitures ($93 million), lower volume ($66 million), an asset impairment charge related to the divestiture of our Nordic and Baltic snacks operation ($55 million), charges for legal matters associated with certain of our U.S. and European operations, including U.S. coffee operations ($55 million), integration costs associated with our LU Biscuit acquisition ($46 million), higher marketing, administration and research costs ($45 million), higher general corporate expenses ($32 million, including higher amortization of intangibles), gains on 2007 divestitures ($20 million) and the impact of divestitures ($13 million). Foreign currency increased operating income by $126 million, due primarily to the continuing strength of the Canadian dollar, Brazilian real and euro against the U.S. dollar.

Earnings per Share – Net earnings of $2,738 million increased by $733 million (36.6%) in the first nine months of 2008. Diluted earnings per share were $1.80, up 44.0% from $1.25 in 2007. During the first nine months of 2008:

 

   

we realized $0.52 per diluted share ($795 million after taxes) from increased earnings from discontinued operations including a gain on the split-off of our Post cereals business ($860 million after taxes);

   

we recorded losses on divestitures of $0.04 per diluted share ($93 million before taxes);

   

we recognized income of $0.26 per diluted share ($646 million before taxes) due to increases in operations (including $0.05 per diluted share of foreign currency movements); we also benefited $0.08 per diluted share from a decrease in shares outstanding; and $0.02 per diluted share from a deferred tax reconciliation;

   

we incurred $0.14 per diluted share ($309 million before taxes) in Restructuring Program costs as compared to $0.13 per diluted share ($325 million before taxes) in the first nine months of 2007; and

 

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we incurred $0.20 per diluted share ($479 million before taxes) in higher interest and other debt expense; $0.02 per diluted share ($44 million before taxes) in higher unrealized losses on certain commodity hedging activities; $0.02 per diluted share ($55 million before taxes) in charges for legal matters; $0.01 per diluted share from increases in our tax rate; and in addition, in the first nine months of 2007, we received $0.03 per diluted share ($77 million before taxes) in interest income from tax reserve transfers from Altria.

Results of Operations by Business Segment

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

Kraft North America’s segments are U.S. Beverages, U.S. Cheese, U.S. Convenient Meals, U.S. Grocery, U.S. Snacks (formerly known as U.S. Snacks & Cereals) and Canada & North America Foodservice. The two international segments are European Union and Developing Markets.

Beginning in the third quarter of 2008, the results of the Post cereals business were reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results were restated in a consistent manner. Refer to our Form 8-K filed with the SEC on September 19, 2008 for additional information reconciling prior period segment results to our restated segment results.

In February 2008, we announced the implementation of our new operating structure. Our new structure reflects our strategy to Rewire the Organization for Growth. Within our new structure, business units now have full P&L accountability and are staffed accordingly. This also ensures that we are putting our resources closer to where decisions are made that affect our consumers and customers. Our corporate and shared service functions continue to streamline their organizations and focus them on core activities that can more efficiently support the goals of the business units. As a result of implementing our new operating structure, we began reporting the results of operations under this new structure in the first quarter of 2008 and restated results from prior periods in a consistent manner. The changes were:

 

   

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

   

Our macaroni and cheese category as well as other dinner products were moved from our U.S. Convenient Meals segment to our U.S. Grocery segment to take advantage of operating synergies.

   

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

On April 11, 2008, we filed a Form 8-K with the SEC related to our new operating structure. Refer to the Form 8-K for additional information reconciling our prior period reportable business segments to our new reportable business segments.

The following discussion compares our operating results of each of our reportable segments for the three months ended September 30, 2008 and 2007, and for the nine months ended September 30, 2008 and 2007.

 

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         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     
         2008     2007     2008     2007      
         (in millions; 2007 restated)     (in millions; 2007 restated)      
 

Net revenues:

          
 

Kraft North America:

          
 

U.S. Beverages

   $ 743     $ 712     $ 2,304     $ 2,277    
 

U.S. Cheese

     919       859       2,848       2,623    
 

U.S. Convenient Meals

     1,081       995       3,202       2,967    
 

U.S. Grocery

     802       757       2,506       2,411    
 

U.S. Snacks (1)

     1,274       1,220       3,736       3,581    
 

Canada & N.A. Foodservice

     1,109       1,053       3,279       2,962    
 

Kraft International:

          
 

European Union

     2,725       1,855       8,357       5,444    
 

Developing Markets

     1,809       1,309       5,202       3,726    
                                   &