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Mondelez International, Inc. 10-Q 2008
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 June 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

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Three Lakes Drive,

Northfield, Illinois

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

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

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 definition 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 June 30, 2008, there were 1,518,113,053 shares of the registrant’s common stock outstanding.

 

 

 


KRAFT FOODS INC.

TABLE OF CONTENTS

 

         Page No.
PART I –  

FINANCIAL INFORMATION

  
Item 1.  

Financial Statements (Unaudited)

  
 

Condensed Consolidated Statements of Earnings for the
Three Months and Six Months Ended June 30, 2008 and 2007

   1
 

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

   2
 

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

   3
 

Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2008 and 2007

   4
 

Notes to Condensed Consolidated Financial Statements

   5-21
Item 2.  

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

   21-39
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

   39
Item 4.  

Controls and Procedures

   40
PART II –  

OTHER INFORMATION

  
Item 1.  

Legal Proceedings

   40
Item 1A.  

Risk Factors

   40
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

   41
Item 4.  

Submission of Matters to a Vote of Security Holders

   41
Item 6.  

Exhibits

   42
Signature    43

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     For the Six Months Ended  
     June 30,     June 30,  
     2008    2007     2008    2007  

Net revenues

   $ 11,176    $ 9,205     $ 21,548    $ 17,791  

Cost of sales

     7,132      5,945       14,023      11,480  
                              

Gross profit

     4,044      3,260       7,525      6,311  

Marketing, administration and research costs

     2,353      1,969       4,564      3,841  

Asset impairment and exit costs

     103      107       183      174  

Losses / (gains) on divestitures, net

     74      (8 )     92      (20 )

Amortization of intangibles

     4      4       11      6  
                              

Operating income

     1,510      1,188       2,675      2,310  

Interest and other debt expense, net

     331      149       636      213  
                              

Earnings before income taxes

     1,179      1,039       2,039      2,097  

Provision for income taxes

     447      332       699      688  
                              

Net earnings

   $          732    $          707     $        1,340    $        1,409  
                              

Per share data:

          

Basic earnings per share

   $ 0.49    $ 0.45     $ 0.89    $ 0.88  
                              

Diluted earnings per share

   $ 0.48    $ 0.44     $ 0.88    $ 0.87  
                              

Dividends declared

   $ 0.27    $ 0.25     $ 0.54    $ 0.50  
                              

See notes to condensed consolidated financial statements.

 

1


Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in millions of dollars)

(Unaudited)

 

     June 30,     December 31,  
     2008     2007  

ASSETS

    

Cash and cash equivalents

   $ 708     $ 567  

Receivables (less allowances of $117 in 2008 and $94 in 2007)

     5,223       5,197  

Inventories:

    

Raw materials

     1,968       1,605  

Finished product

     2,878       2,491  
                

Total inventories

     4,846       4,096  

Deferred income taxes

     481       575  

Other current assets

     416       302  
                

Total current assets

     11,674       10,737  

Property, plant and equipment, at cost

     20,507       19,204  

Less accumulated depreciation

     9,043       8,426  
                

Property, plant and equipment, net

     11,464       10,778  

Goodwill

     30,497       31,193  

Intangible assets, net

     13,840       12,200  

Prepaid pension assets

     1,717       1,648  

Other assets

     1,653       1,437  
                

TOTAL ASSETS

   $      70,845     $      67,993  
                

LIABILITIES

    

Short-term borrowings

   $ 2,217     $ 7,385  

Current portion of long-term debt

     725       722  

Accounts payable

     3,541       4,065  

Accrued marketing

     1,964       1,833  

Accrued employment costs

     835       913  

Other current liabilities

     2,548       2,168  
                

Total current liabilities

     11,830       17,086  

Long-term debt

     19,348       12,902  

Deferred income taxes

     5,675       4,876  

Accrued pension costs

     844       810  

Accrued postretirement health care costs

     2,896       2,846  

Other liabilities

     2,302       2,178  
                

TOTAL LIABILITIES

     42,895       40,698  

Contingencies (Note 12)

    

SHAREHOLDERS’ EQUITY

    

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

            

Additional paid-in capital

     23,441       23,445  

Retained earnings

     12,670       12,209  

Accumulated other comprehensive losses

     (1,174 )     (1,835 )

Treasury stock, at cost

     (6,987 )     (6,524 )
                

TOTAL SHAREHOLDERS’ EQUITY

     27,950       27,295  
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 70,845     $ 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)

 

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

                 1,340                      1,340  

Other comprehensive earnings, net
of income taxes

                        661               661  
                       

Total comprehensive earnings *

                    2,001  
                       

Exercise of stock options and issuance
of other stock awards

          (4 )      (57 )             187        126  

Cash dividends declared
($0.54 per share)

                 (822 )                    (822 )

Common Stock repurchased

                               (650 )      (650 )
                                                   

Balances at June 30, 2008

   $    $           23,441      $           12,670      $           (1,174 )    $            (6,987 )    $          27,950  
                                                   

 

* Total comprehensive earnings were $1,000 million for the quarter ended June 30, 2008, $1,046 million for the quarter ended June 30, 2007 and $1,804 million for the six months ended June 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 Six Months Ended  
   June 30,  
     2008     2007  

CASH PROVIDED BY / (USED IN) OPERATING ACTIVITIES

    

Net earnings

   $ 1,340     $ 1,409  

Adjustments to reconcile net earnings to operating cash flows:

    

Depreciation and amortization

     507       442  

Deferred income tax benefit

     (27 )     (100 )

Losses / (gains) on divestitures, net

     92       (20 )

Asset impairment and exit costs, net of cash paid

     103       59  

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

    

Receivables, net

     64       10  

Inventories

     (665 )     (429 )

Accounts payable

     (168 )     (123 )

Amounts due to Altria Group, Inc. and affiliates

           (88 )

Other working capital items

     (66 )     (322 )

Change in pension assets and postretirement liabilities, net

     14       91  

Other

     155       481  
                

Net cash provided by operating activities

     1,349       1,410  
                

CASH PROVIDED BY / (USED IN) INVESTING ACTIVITIES

    

Capital expenditures

     (590 )     (506 )

Acquisitions, net of cash received

     (99 )      

Proceeds from divestitures

     76       203  

Other

     (4 )     10  
                

Net cash used in investing activities

     (617 )     (293 )
                

CASH PROVIDED BY / (USED IN) FINANCING ACTIVITIES

    

Net (repayment) / issuance of short-term borrowings

     (5,580 )     3,289  

Long-term debt proceeds

     6,459       28  

Long-term debt repaid

     (35 )     (1,034 )

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

           (149 )

Repurchase of Common Stock

     (650 )     (2,207 )

Dividends paid

     (826 )     (820 )

Other

     7       (57 )
                

Net cash used in financing activities

     (625 )     (950 )
                

Effect of exchange rate changes on cash and cash equivalents

     34       13  
                

Cash and cash equivalents:

    

Increase

     141       180  

Balance at beginning of period

     567       239  
                

Balance at end of period

   $           708     $           419  
                

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 the requirements of the SEC 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.

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 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.

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

   

closing up to 35 facilities and eliminating approximately 14,400 positions; and

   

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

We incurred $219 million in charges under the Restructuring Program during the first six months of 2008. Since the inception of the Restructuring Program, we have incurred $2.3 billion in charges and paid cash for $1.2 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 are streamlining their organizations and focusing 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 will eliminate 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 $17 million of implementation costs and $4 million of non-recurring costs during the six months ended June 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.

Restructuring Costs:

Under the Restructuring Program, we recorded asset impairment and exit costs of $103 million during the three months and $183 million during the six months ended June 30, 2008. We expect to pay cash for approximately $149 million of the charges that we incurred during the first six months of 2008. We announced the closure of two plants during the first six months of 2008; since the program began in 2004, we have announced the closure of 32 facilities.

 

6


Restructuring liability activity for the six months ended June 30, 2008 was:

 

         Severance     Asset
Write-downs
    Other     Total  
         (in millions)  
 

Liability balance, January 1, 2008

   $ 154     $     $ 16     $ 170  
 

Charges

     124       40       19       183  
 

Cash (spent) / received

     (90 )     30       (20 )     (80 )
 

Charges against assets

     (1 )     (70 )           (71 )
 

Currency

     6                   6  
                                  
 

Liability balance, June 30, 2008

   $          193     $              –     $            15     $          208  
                                  
          

Severance charges include the cost of benefits received by terminated employees. We have eliminated approximately 13,100 positions as of June 30, 2008; at that time we also announced the elimination of an additional 1,200 positions. Severance charges against assets primarily relate to incremental pension costs, which reduce prepaid pension assets. Asset write-downs relate to the impairment of assets caused by plant closings and related activity. Cash received on asset write-downs relates to proceeds received from the sale of assets that had previously been 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 six months of 2008 will require cash payments.

 

Implementation costs associated with the Restructuring Program were:

      

 

     

 

         For the Three Months Ended     For the Six Months Ended  
         June 30,     June 30,  
         2008     2007     2008     2007  
         (in millions)     (in millions)  
 

Cost of sales

   $ (5 )   $ 25     $ 9     $ 30  
 

Marketing, administration and
research costs

     23       25       27       41  
                                  
 

Total implementation costs

   $            18     $            50     $            36     $            71  
                                  

 

7


Total – Asset Impairment, Exit and Implementation Costs

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

 

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

Kraft North America:

            
 

U.S. Beverages

   $ 6     $    $ 6     $ 1    $ 7  
 

U.S. Cheese

     4            4       3      7  
 

U.S. Convenient Meals

     (1 )          (1 )          (1 )
 

U.S. Grocery

     1            1       1      2  
 

U.S. Snacks & Cereals

     2            2       1      3  
 

Canada & N.A. Foodservice

     29            29            29  
 

Kraft International:

            
 

European Union

     32            32       11      43  
 

Developing Markets

     30            30       1      31  
                                        
 

Total

   $          103     $              –    $          103     $                18    $          121  
                                        
         For the Three Months Ended June 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

   $ 6     $    $ 6     $ 2    $ 8  
 

U.S. Cheese

     27            27       13      40  
 

U.S. Convenient Meals

     1            1       3      4  
 

U.S. Grocery

     14            14       1      15  
 

U.S. Snacks & Cereals

     2            2       6      8  
 

Canada & N.A. Foodservice

     4            4       1      5  
 

Kraft International:

            
 

European Union

     43            43       19      62  
 

Developing Markets

     10            10       5      15  
                                        
 

Total

   $              107     $                  –    $              107     $                50    $              157  
                                        
         For the Six Months Ended June 30, 2008  
         Restructuring
Costs
    Asset
Impairment
   Total Asset
Impairment
and Exit Costs
    Implementation
Costs
   Total  
         (in millions)  
 

Kraft North America:

            
 

U.S. Beverages

   $ 15     $    $ 15     $ 1    $ 16  
 

U.S. Cheese

     9            9       6      15  
 

U.S. Convenient Meals

     8            8            8  
 

U.S. Grocery

     5            5       2      7  
 

U.S. Snacks & Cereals

     10            10       3      13  
 

Canada & N.A. Foodservice

     39            39            39  
 

Kraft International:

            
 

European Union

     59            59       22      81  
 

Developing Markets

     38            38       2      40  
                                        
 

Total

   $ 183     $    $ 183     $ 36    $ 219  
                                        

 

8


         For the Six Months Ended June 30, 2007
                   Total Asset          
         Restructuring    Asset    Impairment    Implementation     
         Costs    Impairment    and Exit Costs    Costs    Total
         (in millions, as restated)
 

Kraft North America:

              
 

U.S. Beverages

   $ 7    $    $ 7    $ 4    $ 11
 

U.S. Cheese

     36           36      16      52
 

U.S. Convenient Meals

     9           9      6      15
 

U.S. Grocery

     17           17      4      21
 

U.S. Snacks & Cereals

     6           6      10      16
 

Canada & N.A. Foodservice

     7           7      2      9
 

Kraft International:

              
 

European Union

     77           77      22      99
 

Developing Markets

     15           15      7      22
                                    
 

Total

   $ 174    $    $              174    $                71    $              245
                                    

 

Note 3. Goodwill and Intangible Assets:

 

Goodwill by reportable segment was:

 

         June 30,    December 31,               
         2008    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

     3,043      3,043         
 

U.S. Snacks & Cereals

     8,245      8,253         
 

Canada & N.A. Foodservice

     2,362      2,364         
 

Kraft International:

              
 

European Union

     8,939      9,392         
 

Developing Markets

     2,158      2,391         
                        
 

Total goodwill

   $          30,497    $         31,193         
                        

 

Intangible assets were:

 

         June 30, 2008    December 31, 2007     
         Intangible    Accumulated    Intangible    Accumulated     
         Assets, at cost    Amortization    Assets, at cost    Amortization     
         (in millions)     
 

Non-amortizable intangible assets

   $ 13,624    $    $ 12,065    $   
 

Amortizable intangible assets

     290      74      197      62   
                                
 

Total other intangible assets

   $ 13,914    $ 74    $ 12,262    $ 62   
                                

 

Non-amortizable intangible assets consist substantially of brand names purchased through our acquisitions of Nabisco Holdings Corp., the global biscuit business of Groupe Danone S.A. (“Danone 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.

 

9


The movements in goodwill and intangible assets were:

 

        
               Intangible                               
         Goodwill     Assets, at cost                               
         (in millions)                               
 

Balance at December 31, 2007

   $ 31,193     $ 12,262                   
 

Changes due to:

                     
 

Foreign currency

     650       225                   
 

Acquisitions

     (1,316 )     1,464                   
 

Divestitures

     (38 )     (37 )                 
 

Other

     8                         
                                   
 

Balance at June 30, 2008

   $       30,497     $       13,914                   
                                   

 

   

Acquisitions – We decreased goodwill by $1,316 million and increased intangible assets by $1,464 million primarily due to refinements of preliminary allocations of purchase price for our acquisition of Danone Biscuit. The allocations were based upon appraisals, which are substantially complete; however, these allocations are subject to revision upon their finalization in the third quarter of 2008.

   

Divestitures – We reduced goodwill by $38 million and intangible assets by $37 million due to the divestiture of a small operation in Spain.

Amortization expense for intangible assets was $4 million during the three months and $11 million during the six months ended June 30, 2008. We currently estimate amortization expense for each of the next five years to be approximately $20 million or less, including the impact of our Danone 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 Danone Biscuit (“Danone Biscuit Bridge Facility”). According to 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) with proceeds from our March 20, 2008 and May 22, 2008 debt issuances discussed below. Upon repayment, this facility was terminated.

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 Danone 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 Danone 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.

 

10


These notes from both issuances discussed above include covenants that restrict our ability to incur debt secured by liens. 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 June 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 6.03%), due through 2039

 

  $ 15,328     $ 13,392  
 

Euro notes, 5.75% to 6.25% (average effective rate 5.86%), due through 2015

 

    4,476        
 

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

 

    179       175  
 

Other foreign currency obligations

 

    12       16  
 

Capital leases and other

 

    78       41  
                 
 

Total long-term debt

 

    20,073       13,624  
 

Less current portion of long-term debt

 

    (725 )     (722 )
                 
 

Long-term debt

 

  $         19,348     $       12,902  
                      

 

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

 

 

 

2009

 

  $ 725    
 

2010

 

    759    
 

2011

 

    709    
 

2012

 

    6,658    
 

2013

 

    756    
 

Thereafter

 

            10,573    

 

Fair Value:

The aggregate fair value of our total long-term debt, based on market quotes, was $19,954 million at June 30, 2008. Quoted prices in active markets for identical liabilities were used to determine the fair value of our long-term debt.

 

Note 5. 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

     626       (5 )           621  
 

Amortization of experience losses and
prior service costs

           46             46  
 

Pension settlement

           13             13  
 

Net actuarial loss arising during period

       (40 )       (40 )
 

Change in fair value of derivatives
accounted for as hedges

                 21       21  
                
 

Total other comprehensive earnings

           661  
                                  
 

Balances at June 30, 2008

   $               575     $          (1,797 )   $    48     $        (1,174 )
                                  

 

11


Note 6.  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.

Additionally, we issued 0.1 million off-cycle shares of restricted and deferred stock during the first six months of 2008. The weighted-average market value per restricted or deferred share was $31.17 on the date of grant. The total number of restricted and deferred shares issued in the first six months of 2008 was 4.9 million, including those issued as part of our long-term incentive plan. We also granted 0.1 million off-cycle stock options during the first six months of 2008 at an exercise price of $30.78.

During the first six months of 2008, 6.0 million shares of restricted and deferred stock vested at a market value of $178.1 million.

There were 3.3 million stock options exercised during the first six months of 2008 with a total intrinsic value of $53.4 million.

Note 7. 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.

 

12


Pension Plans

Components of Net Periodic Pension Cost:

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

 

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

Service cost

   $ 37     $ 39     $ 24     $ 24  
 

Interest cost

     93       91       57       47  
 

Expected return on plan assets

     (131 )     (132 )     (74 )     (61 )
 

Amortization:

        
 

Net loss from experience differences

     22       34       8       17  
 

Prior service cost

     1       1       2       2  
 

Other expense

     13       21              
                                  
 

Net periodic pension cost

   $            35     $            54     $            17     $            29  
                                  
         U.S. Plans     Non-U.S. Plans  
         For the Six Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2008     2007     2008     2007  
         (in millions)  
 

Service cost

   $ 75     $ 79     $ 47     $ 48  
 

Interest cost

     186       182       113       93  
 

Expected return on plan assets

     (263 )     (262 )     (146 )     (120 )
 

Amortization:

        
 

Net loss from experience differences

     43       70       15       32  
 

Prior service cost

     3       3       4       4  
 

Other expense

     21       34              
                                  
 

Net periodic pension cost

   $ 65     $ 106     $ 33     $ 57  
                                  

Retiring employees elected lump-sum payments, resulting in settlement losses of $12 million during the three months and $20 million during the six months ended June 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 $1 million during the second quarter of 2008 for the U.S. plans. These costs are included in other expense above.

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 six months ended June 30, 2008, we contributed $17 million to our U.S. plans and $82 million to our non-U.S. plans. Based on current tax law, we plan to make further contributions of approximately $25 million to our U.S. plans and approximately $81 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.

 

13


Postretirement Benefit Plans

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

 

         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2008     2007     2008     2007  
         (in millions)     (in millions)  
 

Service cost

   $ 10     $ 11     $ 22     $ 24  
 

Interest cost

     46       42       91       88  
 

Amortization:

        
 

Net loss from experience differences

     16       12       28       29  
 

Prior service credit

     (8 )     (7 )     (14 )     (13 )
                                  
 

Net postretirement health care costs

   $ 64     $ 58     $ 127     $ 128  
                                  

 

Postemployment Benefit Plans

 

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

 

 

 

         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2008     2007     2008     2007  
         (in millions)     (in millions)  
 

Service cost

   $ 1     $ 1     $ 2     $ 2  
 

Interest cost

     2       2       3       3  
 

Amortization of net losses / (gains)

           1       (1 )     (1 )
 

Other expense

     64       54       123       59  
                                  
 

Net postemployment costs

   $ 67     $ 58     $ 127     $ 63  
                                  

 

The postemployment benefit plan cost of workforce reduction initiatives announced under the Restructuring Program was $64 million during the three months and $123 million during the six months ended June 30, 2008. These costs are included in other expense above.

 

Note 8.  Earnings Per Share:

 

Basic and diluted EPS were calculated using the following:

 

   

 

 

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

Net earnings

   $ 732     $ 707     $ 1,340     $ 1,409  
                                  
 

Weighted average shares for basic EPS

     1,508       1,587       1,513       1,607  
 

Plus incremental shares from assumed
conversions of stock options, restricted
stock and stock rights

     16       19       18       16  
                                  
 

Weighted average shares for diluted EPS

     1,524       1,606       1,531       1,623  
                                  
 

Basic earnings per share

   $ 0.49     $ 0.45     $ 0.89     $ 0.88  
                                  
 

Diluted earnings per share

   $ 0.48     $ 0.44     $ 0.88     $ 0.87  
                                  

We excluded 0.6 million Kraft stock options for the three months and 11.6 million Kraft stock options for the six months ended June 30, 2008, from the calculation of weighted average shares for diluted EPS because they were antidilutive. For the three months and six months ended June 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.

 

14


Note 9.  Acquisitions:

On November 30, 2007, we acquired Danone Biscuit for €5.1 billion (approximately $7.6 billion) in cash. The acquisition included 32 manufacturing facilities and approximately 14,000 employees. Danone Biscuit contributed net revenues of $869 million for the three months and $1,575 million for the six months ended June 30, 2008. We acquired assets consisting primarily of goodwill of $3,922 million (which will not be deductible for statutory tax purposes), intangible assets of $3,655 million (substantially all of which are indefinite-lived), receivables of $759 million, property plant and equipment of $1,044 million and inventories of $203 million. These purchase price allocations were based upon appraisals, which are substantially complete; however, these allocations are subject to revision upon their finalization 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 Danone Biscuit.

Note 10.  Divestitures:

Post Distribution:

On June 16, 2008, our Board of Directors authorized the split-off of the Post cereals business. This split-off is in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp Holdings, Inc. (“Ralcorp”) after an exchange or distribution to our shareholders. The exchange or distribution is expected to be tax-free to participating shareholders for U.S. federal income tax purposes. On July 17, 2008, Ralcorp shareholders approved the transaction; we had previously obtained the IRS tax-free ruling, and both the U.S. and Canadian anti-trust approvals. This transaction is subject to customary closing conditions. We anticipate that this transaction will close in early August 2008.

The Post cereals business had net revenues of $306 million during the three months and $576 million during the six months ended June 30, 2008 and includes such cereals as Honey Bunches of Oats, Pebbles, Shredded Wheat, Selects, Grape Nuts and Honeycomb. The brands in this transaction are distributed primarily in North America. In addition to the Post brands, the transaction includes four manufacturing facilities and certain manufacturing equipment. We anticipate that approximately 1,230 employees will join Ralcorp following the consummation of the transaction.

In this split-off transaction, our shareholders have 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, our wholly owned subsidiary, will own certain assets and liabilities of the Post cereals business. On June 25, 2008, Cable Holdco filed a registration statement on Form

S-1/S-4 with the SEC announcing the start of the exchange offer. The value of Kraft shares and Cable Holdco common stock is 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 is set to expire at 8:00 a.m., New York City time, on August 4, 2008.

This exchange offer is designed to permit our shareholders to exchange their shares of Kraft Common Stock for shares of Cable Holdco common stock at a 10 percent discount to the per share value of Ralcorp common stock, subject to a limit of 0.6613 shares of Cable Holdco common stock per Kraft share. The Cable Holdco common stock will then immediately be exchanged for shares of Ralcorp common stock on a one-for-one basis following the merger of Cable Holdco and a Ralcorp subsidiary. Ultimately, at the conclusion of this exchange offer and the subsequent merger of Cable Holdco and Ralcorp, Kraft shareholders will own up to 0.6613 shares of Ralcorp for each Kraft share exchanged. Approximately 30.5 million shares of Cable Holdco will be offered in exchange for Kraft Common Stock, subject to adjustments in certain circumstances. The exchange offer will be subject to proration if the offer is over-subscribed. If the exchange offer is consummated but not fully subscribed, then the remaining shares of Cable Holdco common stock owned by Kraft will be distributed as a pro rata dividend to Kraft shareholders. As a result of the exchange offer, the number of shares of our Common Stock outstanding will be reduced.

In exchange for the contribution of the Post cereals business, Cable Holdco will issue approximately $665 million in debt securities, issue shares of its common stock, and assume a $300 million credit facility. Upon closing, we will use the cash equivalent net proceeds, approximately $960 million, to repay debt.

 

15


Other:

As part of our Danone Biscuit acquisition, we divested the following operations as a condition of the EU Commission’s anti-trust approval.

   

During the first six months of 2008, we divested two small operations in Spain. From these divestitures, we received $102 million in proceeds and recorded pre-tax losses of $76 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 Danone Biscuit acquisition. As such, the impacts of these divestitures were reflected as adjustments to the purchase price allocations.

In addition, we divested a small operation in Spain in the first quarter of 2008. From this divestiture, we made $26 million in disbursements and recorded pre-tax losses of $16 million.

In aggregate, we received $76 million in proceeds and recorded pre-tax losses of $92 million on these other divestitures.

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

Note 11. 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. We also sell commodity futures to unprice future purchase commitments. Some of these derivative instruments are highly effective and qualify for hedge accounting treatment under SFAS No. 133. 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 are highly effective and 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 in our condensed consolidated statement of earnings when the related inventory is sold. We expect to transfer an insignificant amount of unrealized gains / (losses) to earnings during the next 12 months, and recognized an insignificant amount during the three and six months ended June 30, 2008. We recorded an insignificant amount of ineffectiveness in our condensed consolidated statement of earnings during the three and six months ended June 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 gains of approximately $225 million during the three months and approximately $285 million during the six months ended June 30, 2008, directly as a component of cost of sales in our condensed consolidated statement of earnings. As of June 30, 2008, we had hedged forecasted commodity transactions for periods not exceeding the next 17 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.

 

16


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 in our condensed consolidated statement of earnings 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 an insignificant amount of unrealized gains / (losses) to earnings during the next 12 months, and recognized an insignificant amount during the three and six months ended June 30, 2008. We recorded no ineffectiveness in our foreign currency cash flow hedges during the first six months of 2008 in our condensed consolidated statement of earnings. 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 in our condensed consolidated statement of earnings, depending on the nature of the underlying transaction. For these derivative instruments, we recognized an insignificant amount during the three and six months ended June 30, 2008 in our condensed consolidated statement of earnings. As of June 30, 2008, we had hedged forecasted foreign currency transactions for periods not exceeding the next 42 months. Excluding intercompany loans, we had hedged forecasted foreign currency transactions for periods not exceeding the next six 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
June 30,
    For the Six Months Ended
June 30,
 
         2008     2007     2008     2007  
         (in millions)     (in millions)  
 

Accumulated gain / (loss) at beginning
of period

   $ 54     $ (2 )   $ 27     $ (4 )
 

Transfer of realized losses / (gains) in fair
value to earnings

     1       (2 )     (2 )     (3 )
 

Unrealized (loss) / gain in fair value

     (7 )     32       23       35  
                                  
 

Accumulated gain at June 30

   $                       48     $                       28     $                       48     $                       28  
                                  

 

Fair Value:

The fair value of our derivatives at June 30, 2008 was:

 

 

 

               Fair Value Measurements at Reporting Date Using:  
         Total
Fair Value
    Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 
    Asset / (Liability)    (in millions)  
 

Derivatives

   $ (408 )   $ (134 )   $ (274 )   $  

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 Danone 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 $59 million during the three months ended, and losses of $243 million during the six months ended June 30, 2008 related to the euro denominated borrowings.

Note 12.   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.

 

17


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 June 30, 2008, the maximum potential payments under our third-party guarantees were $45 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 $39 million on our condensed consolidated balance sheet at June 30, 2008.

Note 13. 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 & 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.

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 are streamlining their organizations and focusing 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 8, 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. 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.

 

18


Segment data were:

 

         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
     
         2008     2007     2008     2007      
         (in millions; 2007 restated)     (in millions; 2007 restated)      
 

Net revenues:

          
 

Kraft North America:

          
 

U.S. Beverages

   $ 789     $ 788     $ 1,561     $ 1,565                   
 

U.S. Cheese

     972       884       1,929       1,764    
 

U.S. Convenient Meals

     1,089       1,012       2,121       1,972    
 

U.S. Grocery

     912       873       1,704       1,654    
 

U.S. Snacks & Cereals

     1,539       1,464       2,969       2,860    
 

Canada & N.A. Foodservice

     1,170       1,041       2,220       1,949    
 

Kraft International:

          
 

European Union

     2,915       1,841       5,634       3,591    
 

Developing Markets

     1,790       1,302       3,410       2,436    
                                    
 

Net revenues

   $      11,176     $        9,205     $      21,548     $      17,791    
                                    
         For the Three Months Ended     For the Six Months Ended      
         June 30,     June 30,      
         2008     2007     2008     2007      
         (in millions; 2007 restated)     (in millions; 2007 restated)      
 

Earnings before income taxes

          
 

Operating income:

          
 

Segment operating income:

          
 

Kraft North America:

          
 

U.S. Beverages

   $ 141     $ 132     $ 278     $ 270    
 

U.S. Cheese

     125       83       240       232    
 

U.S. Convenient Meals

     122       113       227       220    
 

U.S. Grocery

     304       276       544       523    
 

U.S. Snacks & Cereals

     292       251       466       482    
 

Canada & N.A. Foodservice

     140       115       251       198    
 

Kraft International:

          
 

European Union

     164       125       334       243    
 

Developing Markets

     196       136       344       229    
 

Unrealized gains on hedging activities

     78       4       103       12    
 

General corporate expenses

     (48 )     (43 )     (101 )     (93 )  
 

Amortization of intangibles

     (4 )     (4 )     (11 )     (6 )  
                                    
 

Operating income

     1,510       1,188       2,675       2,310    
 

Interest and other debt expense, net

     (331 )     (149 )     (636 )     (213 )  
                                    
 

Earnings before income taxes

   $        1,179     $      1,039     $      2,039     $      2,097    
                                    

We incurred asset impairment, exit and implementation costs of $121 million during the three months and $219 million during the six months ended June 30, 2008. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for a breakout of charges by segment.

As discussed in Note 10. Divestitures, during the first six months of 2008, we divested several small operations in Spain. In aggregate, we recorded pre-tax losses of $92 million on these divestitures. We included these losses in the segment operating income of the European Union segment.

 

19


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

 

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

Snacks

   $ 1,507    $ 2,487    $ 3,994    $ 1,393    $ 1,206    $ 2,599
 

Beverages

     929      1,311      2,240      922      1,147      2,069
 

Cheese

     1,361      506      1,867      1,227      418      1,645
 

Grocery

     1,232      274      1,506      1,181      245      1,426
 

Convenient Meals

     1,442      127      1,569      1,339      127      1,466
                                           
 

Total net revenues

   $       6,471    $       4,705    $      11,176    $       6,062    $       3,143    $       9,205
                                           
         For the Six Months Ended    For the Six Months Ended
         June 30, 2008    June 30, 2007
         Kraft North    Kraft         Kraft North    Kraft     
         America    International    Total    America    International    Total
         (in millions)    (in millions)
 

Snacks

   $ 2,889    $ 4,887    $ 7,776    $ 2,707    $ 2,471    $ 5,178
 

Beverages

     1,817      2,453      4,270      1,808      2,117      3,925
 

Cheese

     2,701      991      3,692      2,417      792      3,209
 

Grocery

     2,259      487      2,746      2,189      431      2,620
 

Convenient Meals

     2,838      226      3,064      2,643      216      2,859
                                           
 

Total net revenues

   $     12,504    $     9,044    $     21,548    $     11,764    $     6,027    $     17,791
                                           

 

Note 14. Subsequent Event:

 

As discussed in Note 10, Divestitures, on June 16, 2008, our Board of Directors authorized the split-off of the Post cereals business. This split-off is in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp after an exchange or distribution to our shareholders. We anticipate that this transaction will close in early August 2008, and beginning in the third quarter of 2008, the results of the Post cereals business will be reflected as discontinued operations on the condensed consolidated statement of earnings and prior period results will be restated in a consistent manner.

 

20


Summary results of operations for the Post cereals business and its impacts on earnings per share were as follows:

 

         For the Three Months Ended   

For the Six Months Ended

         
         June 30,    June 30,          
         2008    2007    2008    2007          
         (in millions, except per share data)          
 

Net revenues

   $       306    $       294    $       576    $       560      
                                   
                   
 

Earnings before income taxes

     110      106      196      189      
 

Provision for income taxes

     42      39      73      70      
                                   
 

Net earnings from operations of
the Post cereals business

   $ 68    $ 67    $ 123    $ 119      
                                   
                   
 

Basic earnings per share:

                 
 

Reported for Kraft

   $ 0.49    $ 0.45    $ 0.89    $ 0.88      
 

Post cereals business

     0.05      0.04      0.08      0.07      
                   
 

Diluted earnings per share:

                 
 

Reported for Kraft

   $ 0.48    $ 0.44    $ 0.88    $ 0.87      
 

Post cereals business

     0.04      0.04      0.08      0.07      
                   
                   
         For the Years Ended                    
         December 31,                    
         2007    2006                    
        

(in millions, except

per share data)

                   
 

Net revenues

   $     1,107    $     1,100            
                           
 

Earnings before income taxes

     365      367            
 

Provision for income taxes

     135      135            
                           
 

Net earnings from operations of
the Post cereals business

   $ 230    $ 232            
                           
 

Basic earnings per share:

                 
 

Reported for Kraft

   $ 1.64    $ 1.86            
 

Post cereals business

     0.15      0.14            
 

Diluted earnings per share:

                 
 

Reported for Kraft

   $ 1.62    $ 1.85            
 

Post cereals business

     0.14      0.14            

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, worldwide 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.

 

21


Executive Summary

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

 

   

Net revenues in the second quarter of 2008 increased 21.4% to $11.2 billion and increased 21.1% to $21.5 billion in the first six months of 2008.

 

   

Diluted EPS in the second quarter of 2008 increased 9.1% to $0.48 and increased 1.1% to $0.88 in the first six months of 2008.

 

   

We recorded Restructuring Program charges of $121 million during the three months and $219 million during the six months ended June 30, 2008.

 

   

On November 30, 2007, we acquired the global biscuit business of Groupe Danone S.A. for €5.1 billion (approximately $7.6 billion) in cash. Danone Biscuit contributed net revenues of $869 million during the three months and $1,575 million during the six months ended June 30, 2008.

 

   

On June 16, 2008, our Board of Directors authorized the split-off of the Post cereals business. This split-off is in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp Holdings, Inc. after an exchange or distribution to our shareholders. We anticipate that this transaction will close in early August 2008.

 

   

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 our bridge facility used to fund our Danone Biscuit acquisition and other short-term borrowings.

 

   

During the first six months of 2008, we repurchased 21.3 million shares of our Common Stock for $650 million under our $5.0 billion share repurchase program. During the second quarter of 2008, we did not repurchase any shares of our Common Stock under the program. We had $850 million remaining under our share repurchase program at June 30, 2008.

 

22


Discussion and Analysis

Summary of Financial Results

The following table shows the significant changes in our net earnings and diluted EPS between the three months ended June 30, 2008 and 2007, and between the six months ended June 30, 2008 and 2007 (in millions, except per share data):

 

         For the Three Months Ended     For the Six Months Ended  
         Net     Diluted     Net     Diluted  
         Earnings     EPS     Earnings     EPS  
 

June 30, 2007

   $ 707     $ 0.44     $ 1,409     $ 0.87  
 

2008 Losses on divestitures, net

     (63 )     (0.04 )     (64 )     (0.04 )
 

2007 (Gains) / losses on divestitures, net

     (6 )           2        
 

Lower Restructuring Program costs

     18       0.01       5        
 

European Union segment reorganization

     (1 )           (4 )      
 

Increased gains on unrealized hedging
activities

     49       0.03       59       0.04  
 

Increases in operations

     194       0.11       237       0.14  
 

Higher interest expense

     (120 )     (0.07 )     (225 )     (0.14 )
 

2007 Interest from tax reserve transfers
from Altria Group, Inc.

                 (50 )     (0.03 )
 

Other changes in taxes

     (46 )     (0.03 )     (29 )     (0.02 )
 

Fewer shares outstanding

           0.03             0.06  
                                  
 

June 30, 2008

   $           732     $         0.48     $       1,340     $         0.88  
                                  

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

Acquisitions and Divestitures

Danone Biscuit:

On November 30, 2007, we acquired the global biscuit business of Groupe Danone S.A. (“Danone Biscuit”) for €5.1 billion (approximately $7.6 billion) in cash. The acquisition included 32 manufacturing facilities and approximately 14,000 employees. Danone Biscuit contributed net revenues of $869 million during the three months and $1,575 million during the six months ended June 30, 2008. We acquired assets consisting primarily of goodwill of $3,922 million (which will not be deductible for statutory tax purposes), intangible assets of $3,655 million (substantially all of which are indefinite-lived), receivables of $759 million, property plant and equipment of $1,044 million and inventories of $203 million. These purchase price allocations were based upon appraisals, which are substantially complete; however, these allocations are subject to revision upon their finalization 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 $182 million during the three months and $346 million during the six months ended June 30, 2008 (after considering $77 million in interest income received from Altria in the first quarter of 2007).

Post Distribution:

On June 16, 2008, our Board of Directors authorized the split-off of the Post cereals business. This split-off is in connection with our November 15, 2007 agreement to distribute and merge the Post cereals business into Ralcorp Holdings, Inc. (“Ralcorp”) after an exchange or distribution to our shareholders. The exchange or distribution is expected to be tax-free to participating shareholders for U.S. federal income tax purposes. On July 17, 2008, Ralcorp shareholders approved the transaction; we had previously obtained the IRS tax-free ruling, and both the U.S. and Canadian anti-trust approvals. This transaction is subject to customary closing conditions. We anticipate that this transaction will close in early August 2008.

The Post cereals business had net revenues of $306 million during the three months and $576 million during the six months ended June 30, 2008 and includes such cereals as Honey Bunches of Oats, Pebbles, Shredded Wheat, Selects, Grape Nuts and Honeycomb. The brands in this transaction are distributed primarily in North America. In addition to the Post brands, the transaction includes four manufacturing facilities and certain manufacturing equipment. We anticipate that approximately 1,230 employees will join Ralcorp following the consummation of the transaction.

 

23


In this split-off transaction, our shareholders have 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, our wholly owned subsidiary, will own certain assets and liabilities of the Post cereals business. On June 25, 2008, Cable Holdco filed a registration statement on Form S-1/S-4 with the SEC announcing the start of the exchange offer. The value of Kraft shares and Cable Holdco common stock is 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 is set to expire at 8:00 a.m., New York City time, on August 4, 2008.

This exchange offer is designed to permit our shareholders to exchange their shares of Kraft Common Stock for shares of Cable Holdco common stock at a 10 percent discount to the per share value of Ralcorp common stock, subject to a limit of 0.6613 shares of Cable Holdco common stock per Kraft share. The Cable Holdco common stock will then immediately be exchanged for shares of Ralcorp common stock on a one-for-one basis following the merger of Cable Holdco and a Ralcorp subsidiary. Ultimately, at the conclusion of this exchange offer and the subsequent merger of Cable Holdco and Ralcorp, Kraft shareholders will own up to 0.6613 shares of Ralcorp for each Kraft share exchanged. Approximately 30.5 million shares of Cable Holdco will be offered in exchange for Kraft Common Stock, subject to adjustments in certain circumstances. The exchange offer will be subject to proration if the offer is over-subscribed. If the exchange offer is consummated but not fully subscribed, then the remaining shares of Cable Holdco common stock owned by Kraft will be distributed as a pro rata dividend to Kraft shareholders. As a result of the exchange offer, the number of shares of our Common Stock outstanding will be reduced.

In exchange for the contribution of the Post cereals business, Cable Holdco will issue approximately $665 million in debt securities, issue shares of its common stock, and assume a $300 million credit facility. Upon closing, we will use the cash equivalent net proceeds, approximately $960 million, to repay debt.

Other:

As part of our Danone Biscuit acquisition, we divested the following operations as a condition of the EU Commission’s anti-trust approval.

   

During the first six months of 2008, we divested two small operations in Spain. From these divestitures, we received $102 million in proceeds and recorded pre-tax losses of $76 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 Danone Biscuit acquisition. As such, the impacts of these divestitures were reflected as adjustments to the purchase price allocations.

In addition, we divested a small operation in Spain in the first quarter of 2008. From this divestiture, we made $26 million in disbursements and recorded pre-tax losses of $16 million.

In aggregate, we received $76 million in proceeds and recorded pre-tax losses of $92 million, or $0.04 per diluted share, on these other divestitures.

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

   

closing up to 35 facilities and eliminating approximately 14,400 positions;

   

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

   

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

 

24


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 are streamlining their organizations and focusing 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 will eliminate approximately 700 positions as we streamline our headquarters functions.

We incurred charges under the Restructuring Program of $121 million, or $0.05 per diluted share, during the three months and $219 million, or $0.10 per diluted share, during the six months ended June 30, 2008, and $157 million, or $0.06 per diluted share, during the three months and $245 million, or $0.10 per diluted share, during the six months ended June 30, 2007. Since the inception of the Restructuring Program, we have incurred $2.3 billion in charges, and paid cash for $1.2 billion related to those charges through June 30, 2008. We announced the closure of two plants during the first six months of 2008; since the program began in 2004, we have announced the closure of 32 facilities. Additionally, we have eliminated approximately 13,100 positions as of June 30, 2008; at that time we also announced the elimination of an additional 1,200 positions.

Under the Restructuring Program, we recorded asset impairment and exit costs of $103 million during the three months and $183 million during six months ended June 30, 2008, and $107 million during the three months and $174 million during the six months ended June 30, 2007. We recorded implementation costs of $18 million during the three months and $36 million during the six months ended June 30, 2008, and $50 million during the three months and $71 million during the six months ended June 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.

In addition, we expect to spend approximately $550 million in capital to implement the Restructuring Program. We have spent $441 million in capital since the inception of the Restructuring Program, including $54 million spent in the first six months of 2008. Cumulative annualized cost savings resulting from the Restructuring Program were approximately $783 million through 2007. Incremental cost savings totaled approximately $144 million in the first six months of 2008, resulting in cumulative annualized savings under the Restructuring Program of approximately $927 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 $17 million of implementation costs and $4 million of non-recurring costs during the six months ended June 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.

Provision for Income Taxes

Our effective tax rate was 37.9% in the second quarter of 2008 and 34.3% in the first six months of 2008. Our effective tax rate includes net tax benefits of $13 million in the second quarter of 2008 primarily resulting from the tax impact of the divestiture of a small operation in Spain. For the first six months of 2008, our effective tax rate includes net tax benefits of $79 million, primarily resulting from the resolution of state tax audits, the resolution of outstanding items in our international operations, the tax impact in the first quarter from the divestitures of two small operations in Spain and the second quarter divestiture discussed above.

 

25


Our effective tax rate was 32.0% in the second quarter of 2007 and 32.8% in the first six months of 2007. Our effective tax rate includes net tax benefits of $19 million in the second quarter of 2007 primarily resulting from the resolution of outstanding items in our international operations and various state jurisdictions. For the first six months of 2007, the effective tax rate includes net tax benefits of $8 million primarily resulting from the resolution of outstanding foreign items and repatriation benefits, 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.

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 will 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 June 30, 2008 and 2007, and for the six months ended June 30, 2008 and 2007.

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

 

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

Net revenues

   $       11,176    $         9,205    $         1,971              21.4%                   
 

Operating income

     1,510      1,188      322     27.1%    
 

Net earnings

     732      707      25     3.5%    
 

Diluted earnings per share

     0.48      0.44      0.04     9.1%    
         For the Six Months Ended
June 30,
                
         2008    2007    $ change     % change      
         (in millions, except
per share data)
                
 

Net revenues

   $ 21,548    $ 17,791    $ 3,757     21.1%    
 

Operating income

     2,675      2,310      365     15.8%    
 

Net earnings

     1,340      1,409      (69 )   (4.9% )  
 

Diluted earnings per share

     0.88      0.87      0.01     1.1%    

 

26


Three Months Ended June 30:

Net Revenues – Net revenues increased $1,971 million (21.4%), due to the impact of our Danone Biscuit acquisition (9.6 pp), higher net pricing (6.7 pp), favorable foreign currency (5.6 pp), favorable mix (0.7 pp) and the favorable resolution of a Brazilian value added tax claim (0.5 pp), partially offset by lower volume (1.0 pp) and the impact of divestitures (0.7 pp). Foreign currency increased net revenues by $513 million, due primarily to the continuing strength of the euro, Canadian dollar and Brazilian real against the U.S. dollar. Total volume increased 4.2%, with 5.2 pp due to our Danone Biscuit acquisition, net of divestitures. In addition, higher base business shipments in our Canada & N.A. Foodservice, Convenient Meals and Developing Market segments were more than offset by declines in our remaining business segments.

Operating Income – Operating income increased $322 million (27.1%), due primarily to higher pricing ($616 million), the impact of our Danone Biscuit acquisition ($106 million), favorable resolution of a Brazilian value added tax claim ($40 million), lower Restructuring Program costs ($36 million) and favorable mix ($26 million). Offsetting these favorable items were higher input costs ($378 million, primarily higher raw material costs, partially offset by gains from certain commodity hedging activities for requirements in future quarters), losses on 2008 divestitures ($74 million), lower volume ($40 million), higher fixed manufacturing costs ($22 million), integration costs associated with our Danone Biscuit acquisition ($22 million), higher marketing, administration and research costs ($16 million) and a gain on a 2007 divestiture ($8 million). Foreign currency increased operating income by $63 million, due primarily to the continuing strength of the euro, Canadian dollar and Brazilian real against the U.S. dollar.

Earnings per Share – Net earnings of $732 million increased by $25 million (3.5%) in the second quarter 2008. Diluted earnings per share were $0.48, up 9.1% from $0.44 in 2007. During the second quarter of 2008, we incurred $0.07 per diluted share ($182 million before taxes) in higher interest and other debt expense; we incurred $0.05 per diluted share ($121 million before taxes) in Restructuring Program costs in the second quarter of 2008 as compared to $0.06 per diluted share ($157 million before taxes) in the second quarter of 2007; we recorded losses on divestitures of $0.04 per diluted share ($74 million before taxes) in the second quarter of 2008; and we had a $0.03 per diluted share negative impact from increases in our second quarter tax rate. Also, during the second quarter of 2008, we benefited $0.03 per diluted share from a decrease in shares outstanding, $0.03 per diluted share from increased gains in unrealized hedging activities and recognized income of $0.11 per diluted share ($295 million before taxes) due to increases in operations (including $0.03 per diluted share of foreign currency movements).

Six Months Ended June 30:

Net Revenues – Net revenues increased $3,757 million (21.1%), due to the impact of our Danone Biscuit acquisition (8.9 pp), higher net pricing (5.5 pp), favorable foreign currency (5.3 pp), favorable mix (2.2 pp) and the favorable resolution of a Brazilian value added tax claim (0.3 pp), partially offset by the impact of divestitures (0.6 pp) and lower volume (0.5 pp). Foreign currency increased net revenues by $942 million, due primarily to the continuing strength of the euro, Canadian dollar and Brazilian real against the U.S. dollar. Total volume increased 5.1%, with 5.6 pp due to our Danone Biscuit acquisition, net of divestitures. In addition, higher base business shipments in our international, Canada & N.A. Foodservice and Convenient Meals segments were more than offset by declines in our remaining business segments.

Operating Income – Operating income increased $365 million (15.8%), due primarily to higher pricing ($975 million), the impact of our Danone Biscuit acquisition ($191 million), favorable mix ($152 million), favorable resolution of a Brazilian value added tax claim ($43 million) and lower Restructuring Program costs ($26 million). Offsetting these favorable items were higher input costs ($835 million, primarily higher raw material costs, partially offset by gains from certain commodity hedging activities for requirements in future quarters), losses on 2008 divestitures ($92 million), higher marketing, administration and research costs ($87 million, including higher marketing support), lower volume ($39 million), integration costs associated with our Danone Biscuit acquisition ($27 million) and gains on 2007 divestitures ($20 million). Foreign currency increased operating income by $97 million, due primarily to the continuing strength of the euro, Canadian dollar and Brazilian real against the U.S. dollar.

Earnings per Share – Net earnings of $1,340 million decreased by $69 million (4.9%) in the first six months of 2008. Diluted earnings per share were $0.88, up 1.1% from $0.87 in 2007. During the first six months of 2008, we incurred $0.14 per diluted share ($346 million before taxes) in higher interest and other debt expense; we incurred $0.10 per diluted share ($219 million before taxes) in Restructuring Program costs in the first six months of 2008 as compared to $0.10 per diluted share ($245 million before taxes) in the first six months of 2007; we recorded losses on divestitures of $0.04 per diluted share ($92 million before taxes) in the first six months of 2008; in the first six months of 2007, we received $0.03 per diluted share ($77 million before taxes) in interest income from tax reserve transfers from Altria; and we had a $0.02 per diluted share negative impact from increases in our tax rate in the first six months of 2008. Also, during the first six months of 2008, we benefited $0.06 per diluted share from a decrease in shares outstanding, $0.04 per diluted share from increased gains in unrealized hedging activities and recognized income of $0.14 per diluted share ($364 million before taxes) due to increases in operations (including $0.04 per diluted share of foreign currency movements).

 

27


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 & Cereals, and Canada & North America Foodservice. The two international segments are European Union and Developing Markets.

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 are streamlining their organizations and focusing 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 8, 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 June 30, 2008 and 2007, and for the six months ended June 30, 2008 and 2007.

 

         For the Three Months Ended
June 30,
   For the Six Months Ended
June 30,
     
         2008    2007    2008    2007      
         (in millions; 2007 restated)    (in millions; 2007 restated)      
 

Net revenues:

             
 

Kraft North America:

             
 

U.S. Beverages

   $ 789    $ 788    $ 1,561    $ 1,565                   
 

U.S. Cheese

     972      884      1,929      1,764    
 

U.S. Convenient Meals

     1,089      1,012      2,121      1,972    
 

U.S. Grocery

     912      873      1,704      1,654    
 

U.S. Snacks & Cereals

     1,539      1,464      2,969      2,860    
 

Canada & N.A. Foodservice

     1,170      1,041      2,220      1,949    
 

Kraft International:

             
 

European Union

     2,915      1,841      5,634      3,591    
 

Developing Markets

     1,790      1,302      3,410      2,436    
                                 
 

Net revenues

   $      11,176    $        9,205    $      21,548    $      17,791    
                                 

 

28


         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
     
         2008     2007     2008     2007      
         (in millions; 2007 restated)     (in millions; 2007 restated)      
 

Operating income:

          
 

Segment operating income:

          
 

Kraft North America:

          
 

U.S. Beverages

   $ 141     $ 132     $ 278     $ 270                   
 

U.S. Cheese

     125       83       240       232    
 

U.S. Convenient Meals

     122       113       227       220    
 

U.S. Grocery

     304       276       544       523    
 

U.S. Snacks & Cereals

     292       251       466       482    
 

Canada & N.A. Foodservice

     140       115       251       198    
 

Kraft International:

          
 

European Union

     164       125       334       243    
 

Developing Markets

     196       136       344       229    
 

Unrealized gains on
hedging activities

     78       4       103       12    
 

General corporate expenses

     (48 )     (43 )     (101 )     (93 )  
 

Amortization of intangibles

     (4 )     (4 )     (11 )     (6 )  
                                    
 

Operating income

   $        1,510     $        1,188     $        2,675     $        2,310    
                                    

 

As discussed in Note 13, Segment Reporting, 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. 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 incurred asset impairment, exit and implementation costs of $121 million during the three months and $219 million during the six months ended June 30, 2008, and $157 million during the three months and $245 million during the six months ended June 30, 2007. Refer to Note 2, Asset Impairment, Exit and Implementation Costs, for a breakout of charges by segment.

 

U.S. Beverages

         For the Three Months Ended
June 30,
                 
         2008     2007     $ change     % change      
         (in millions; 2007 restated)                  
 

Net revenues

   $ 789     $ 788     $ 1       0.1%                   
 

Segment operating income

     141       132       9       6.8%    
         For the Six Months Ended
June 30,
                 
         2008     2007     $ change     % change      
         (in millions; 2007 restated)                  
 

Net revenues

   $        1,561     $        1,565     $             (4 )              (0.3% )  
 

Segment operating income

     278       270       8       3.0%    

Three Months Ended June 30:

Net revenues increased $1 million (0.1%), due to higher net pricing (6.0 pp) and favorable mix (2.0 pp), offset by lower volume (4.6 pp) and the impact of divestitures (3.3 pp). Volume declines in the quarter were driven by ready-to-drink beverages, primarily Capri Sun and Kool-Aid, partially offset by gains in powdered beverages and Maxwell House mainstream coffee. Favorable mix was driven by gains in Crystal Light On the Go sticks and growth in mainstream coffee. Higher net pricing reflected input cost-driven pricing in coffee and lower promotional spending in ready-to-drink and powdered beverages.

 

29


Segment operating income increased $9 million (6.8%), due primarily to higher net pricing and favorable mix, partially offset by higher raw material costs and lower volume.

Six Months Ended June 30:

Net revenues decreased $4 million (0.3%), due to lower volume (8.4 pp) and the impact of divestitures (3.2 pp), partially offset by favorable mix (5.8 pp) and higher net pricing (5.5 pp). Volume declines for the first six months were driven by ready-to-drink beverages, primarily Capri Sun and Kool-Aid. Favorable mix was driven by Crystal Light On the Go sticks and Tassimo growth. Higher net pricing reflected input cost-driven pricing in coffee and lower promotional spending in ready-to-drink and powdered beverages.

Segment operating income increased $8 million (3.0%), due primarily to higher net pricing and favorable mix, partially offset by lower volume and higher raw material costs (primarily coffee and packaging).

U.S. Cheese