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Mondelez International, Inc. 10-Q 2009
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, 2009
   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: (i) 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 (ii) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  x    Accelerated filer  ¨   

Non-accelerated filer  ¨

(Do not check if a smaller reporting company)

   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  x

At June 30, 2009, there were 1,474,965,403 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, 2009 and 2008

   1
 

Condensed Consolidated Balance Sheets at
June 30, 2009 and December 31, 2008

   2
 

Condensed Consolidated Statements of Equity
for the Year Ended December 31, 2008 and the
Six Months Ended June 30, 2009

   3
 

Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2009 and 2008

   4
 

Notes to Condensed Consolidated Financial Statements

   5
Item 2.  

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

   22
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

   41
Item 4.  

Controls and Procedures

   41
PART II –  

OTHER INFORMATION

  
Item 1.  

Legal Proceedings

   41
Item 1A.  

Risk Factors

   41
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

   42
Item 4.  

Submission of Matters to a Vote of Security Holders

   42
Item 6.  

Exhibits

   43
Signature      44

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

 

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
June 30,
   For the Six Months Ended
June 30,
     2009     2008    2009     2008

Net revenues

   $ 10,162      $ 10,804    $ 19,558      $ 20,850

Cost of sales

     6,497        6,936      12,628        13,681
                             

Gross profit

     3,665        3,868      6,930        7,169

Marketing, administration and research costs

     2,140        2,264      4,131        4,393

Asset impairment and exit costs

     (26     103      (26     183

Losses on divestitures, net

     17        74      17        92

Amortization of intangibles

     3        4      9        11
                             

Operating income

     1,531        1,423      2,799        2,490

Interest and other expense, net

     312        331      592        636
                             

Earnings from continuing operations before
income taxes

     1,219        1,092      2,207        1,854

Provision for income taxes

     390        414      716        629
                             

Earnings from continuing operations

     829        678      1,491        1,225

Earnings from discontinued operations, net of
income taxes (Note 2)

            69             123
                             

Net earnings

     829        747      1,491        1,348

Noncontrolling interest

     2        2      4        4
                             

Net earnings attributable to Kraft Foods

   $          827      $          745    $       1,487      $       1,344
                             

Per share data:

         

Basic earnings per share attributable to
Kraft Foods:

         

Continuing operations

   $ 0.56      $ 0.44    $ 1.01      $ 0.80

Discontinued operations

            0.05             0.08
                             

Net earnings attributable to Kraft Foods

   $ 0.56      $ 0.49    $ 1.01      $ 0.88
                             

Diluted earnings per share attributable to
Kraft Foods:

         

Continuing operations

   $ 0.56      $ 0.44    $ 1.00      $ 0.79

Discontinued operations

            0.05             0.08
                             

Net earnings attributable to Kraft Foods

   $ 0.56      $ 0.49    $ 1.00      $ 0.87
                             

Dividends declared

   $ 0.29      $ 0.27    $ 0.58      $ 0.54

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,  
     2009     2008  

ASSETS

    

Cash and cash equivalents

   $        1,731      $ 1,244   

Receivables (less allowances of $122 in 2009 and $129 in 2008)

     4,646        4,704   

Inventories, net

     4,011        3,881   

Deferred income taxes

     682        804   

Other current assets

     618        828   
                

Total current assets

     11,688        11,461   

Property, plant and equipment, net

     10,224        9,917   

Goodwill

     28,225        27,581   

Intangible assets, net

     13,257        12,926   

Prepaid pension assets

     100        56   

Other assets

     1,160        1,232   
                

TOTAL ASSETS

   $ 64,654      $ 63,173   
                

LIABILITIES

    

Short-term borrowings

   $ 856      $ 897   

Current portion of long-term debt

     759        765   

Accounts payable

     3,225        3,373   

Accrued marketing

     1,869        1,803   

Accrued employment costs

     847        951   

Other current liabilities

     2,747        3,255   
                

Total current liabilities

     10,303        11,044   

Long-term debt

     18,610        18,589   

Deferred income taxes

     4,266        4,064   

Accrued pension costs

     2,209        2,367   

Accrued postretirement health care costs

     2,682        2,678   

Other liabilities

     2,204        2,075   
                

TOTAL LIABILITIES

     40,274        40,817   

Contingencies (Note 10)

    

EQUITY

    

Common Stock, no par value (1,735,000,000 shares
issued in 2009 and 2008)

              

Additional paid-in capital

     23,517        23,563   

Retained earnings

     14,016        13,440   

Accumulated other comprehensive losses

     (4,723     (5,994

Treasury stock, at cost

     (8,514     (8,714
                

Total Kraft Foods Shareholders’ Equity

     24,296        22,295   

Noncontrolling interest

     84        61   
                

TOTAL EQUITY

     24,380        22,356   
                

TOTAL LIABILITIES AND EQUITY

   $ 64,654      $ 63,173   
                

See notes to condensed consolidated financial statements.

 

2


Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Statements of Equity

(in millions of dollars, except per share data)

(Unaudited)

 

     Kraft Foods Shareholders’ Equity                
     Common
Stock
   Additional
Paid-in

Capital
     Retained
Earnings
     Accumulated
Other
Comprehensive
Earnings /
(Losses)
     Treasury
Stock
     Noncontrolling
Interest
     Total
Equity
 

Balances at January 1, 2008

   $                       –    $              23,445       $              12,321       $ (1,835    $ (6,524    $                     38       $              27,445   

Comprehensive earnings / (losses):

                    

Net earnings

                  2,884                         9         2,893   

Other comprehensive losses, net
of income taxes

                          (4,159              (9      (4,168
                                

Total comprehensive losses *

                            (1,275
                                

Adoption of FASB Statement
No. 158, net of income taxes

                  (8                              (8

Exercise of stock options and issuance
of other stock awards

          118         (81                                231                 268   

Cash dividends declared
($1.12 per share)

                  (1,676                              (1,676

Acquisitions of noncontrolling
interest and other activities

                                          23         23   

Common Stock repurchased

                                  (777              (777

Common Stock tendered

                                  (1,644              (1,644
                                                            

Balances at December 31, 2008

   $    $ 23,563       $ 13,440       $ (5,994    $ (8,714    $ 61       $ 22,356   

Comprehensive earnings / (losses):

                    

Net earnings

                  1,487                         4         1,491   

Other comprehensive earnings, net
of income taxes

                          1,271                 22         1,293   
                                

Total comprehensive earnings *

                    26         2,784   
                                

Exercise of stock options and issuance
of other stock awards

          (46      (55              200                 99   

Cash dividends declared
($0.58 per share)

                  (856                              (856

Dividends paid on noncontrolling
interest and other activities

                                          (3      (3
                                                            

Balances at June 30, 2009

   $    $ 23,517       $ 14,016       $ (4,723    $ (8,514    $ 84       $ 24,380   
                                                            

 

* Total comprehensive earnings / (losses) were $2,274 million for the quarter ended June 30, 2009, $1,017 million for the quarter ended June 30, 2008 and $2,012 million for the six months ended June 30, 2008. Comprehensive earnings / (losses) attributable to Kraft Foods were $2,250 million for the quarter ended June 30, 2009, $2,758 million for the six months ended June 30, 2009, $1,013 million for the quarter ended June 30, 2008 and $2,005 million for the six months ended June 30, 2008.

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,
 
     2009     2008  

CASH PROVIDED BY / (USED IN) OPERATING ACTIVITIES

    

Net earnings

   $        1,491      $        1,348   

Adjustments to reconcile net earnings to operating cash flows:

    

Depreciation and amortization

     432        507   

Stock-based compensation expense

     84        93   

Deferred income tax provision / (benefit)

     110        (10

Losses on divestitures, net

     17        92   

Asset impairment and exit costs, net of cash paid

     9        103   

Other non-cash expense, net

     147        58   

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

    

Receivables, net

     373        64   

Inventories, net

     (22     (672

Accounts payable

     (303     (168

Other current assets

     197        (153

Other current liabilities

     (701     73   

Change in pension and postretirement assets and liabilities, net

     (114     14   
                

Net cash provided by operating activities

     1,720        1,349   
                

CASH PROVIDED BY / (USED IN) INVESTING ACTIVITIES

    

Capital expenditures

     (474     (590

Acquisitions, net of cash received

            (99

Proceeds from divestitures

     6        76   

Other

     37        (4
                

Net cash used in investing activities

     (431     (617
                

CASH PROVIDED BY / (USED IN) FINANCING ACTIVITIES

    

Net repayment of short-term borrowings

     (41     (5,580

Long-term debt proceeds

     1        6,459   

Long-term debt repaid

     (12     (35

Repurchase of Common Stock

            (650

Dividends paid

     (855     (826

Other

     10        7   
                

Net cash used in financing activities

     (897     (625
                

Effect of exchange rate changes on cash and cash equivalents

     95        34   
                

Cash and cash equivalents:

    

Increase

     487        141   

Balance at beginning of period

     1,244        567   
                

Balance at end of period

   $ 1,731      $ 708   
                

See notes to condensed consolidated financial statements.

 

4


Kraft Foods Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1.  Summary of Significant Accounting Policies:

Basis of Presentation:

Our interim condensed consolidated financial statements are unaudited. We prepared the condensed consolidated financial statements following SEC rules for interim reporting. As permitted under those rules, we have condensed or omitted a number of footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America. 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 for the year ended December 31, 2008.

Inventories:

Effective January 1, 2009, we changed our method of valuing our U.S. inventories to the average cost method. In prior years, principally all U.S. inventories were valued using the last-in, first-out (“LIFO”) method. With this change, we value all of our inventories using the average cost method. We used the LIFO method to determine the cost of 35% of inventories at December 31, 2008. We believe that the average cost method of accounting for U.S. inventories is preferable and will improve financial reporting by better matching revenues and expenses to current costs, by better aligning our external reporting with our competitors, and by aligning our external reporting with our tax basis of accounting. We restated prior years’ financial statements to conform to the change in accounting policy.

The following line items within the statements of earnings were affected by the change in accounting policy:

 

         For the Three Months Ended June 30, 2009      
         As Computed
under LIFO
   As Reported under
Average Cost
   Favorable /
(Unfavorable)
     
         (in millions, except per share data)      
 

Cost of sales

   $ 6,470    $ 6,497    $                (27  
 

Provision for income taxes

     400      390      10     
 

Earnings from continuing operations

     846      829      (17  
 

Earnings from discontinued operations,
net of income taxes

                   
 

Net earnings attributable to Kraft Foods

     844      827      (17  
 

Basic earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 0.57    $ 0.56    $ (0.01  
 

Discontinued operations

                   
                          
 

Net earnings attributable to Kraft Foods

   $ 0.57    $ 0.56    $ (0.01  
                          
 

Diluted earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 0.57    $ 0.56    $ (0.01  
 

Discontinued operations

                   
                          
 

Net earnings attributable to Kraft Foods

   $                0.57    $ 0.56    $ (0.01  
                          

 

5


         For the Three Months Ended June 30, 2008      
         As Computed
under LIFO
   As Reported under
Average Cost
   Favorable /
(Unfavorable)
     
         (in millions, except per share data)      
 

Cost of sales

   $                 6,958    $ 6,936    $                     22     
 

Provision for income taxes

     405      414      (9  
 

Earnings from continuing operations

     665      678      13     
 

Earnings from discontinued operations,
net of income taxes

     68      69      1     
 

Net earnings attributable to Kraft Foods

     731      745      14     
 

Basic earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 0.44    $ 0.44    $     
 

Discontinued operations

     0.04      0.05      0.01     
                          
 

Net earnings attributable to Kraft Foods

   $ 0.48    $ 0.49    $ 0.01     
                          
 

Diluted earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 0.44    $ 0.44    $     
 

Discontinued operations

     0.04      0.05      0.01     
                          
 

Net earnings attributable to Kraft Foods

   $ 0.48    $ 0.49    $ 0.01     
                          
         For the Six Months Ended June 30, 2009      
         As Computed
under LIFO
   As Reported under
Average Cost
   Favorable /
(Unfavorable)
     
         (in millions, except per share data)      
 

Cost of sales

   $ 12,573    $ 12,628    $ (55  
 

Provision for income taxes

     736      716      20     
 

Earnings from continuing operations

     1,526      1,491      (35  
 

Earnings from discontinued operations,
net of income taxes

                   
 

Net earnings attributable to Kraft Foods

     1,522      1,487      (35  
 

Basic earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 1.03    $ 1.01    $ (0.02  
 

Discontinued operations

                   
                          
 

Net earnings attributable to Kraft Foods

   $ 1.03    $ 1.01    $ (0.02  
                          
 

Diluted earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 1.03    $ 1.00    $ (0.03  
 

Discontinued operations

                   
                          
 

Net earnings attributable to Kraft Foods

   $ 1.03    $ 1.00    $ (0.03  
                          

 

6


         For the Six Months Ended June 30, 2008      
         As Computed
under LIFO
   As Reported under
Average Cost
   Favorable /
(Unfavorable)
     
         (in millions, except per share data)      
 

Cost of sales

   $               13,690    $ 13,681    $                       9     
 

Provision for income taxes

     626      629      (3  
 

Earnings from continuing operations

     1,219      1,225      6     
 

Earnings from discontinued operations,
net of income taxes

     123      123          
 

Net earnings attributable to Kraft Foods

     1,338      1,344      6     
 

Basic earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 0.80    $ 0.80    $     
 

Discontinued operations

     0.08      0.08          
                          
 

Net earnings attributable to Kraft Foods

   $ 0.88    $ 0.88    $     
                          
 

Diluted earnings per share attributable
to Kraft Foods:

          
 

Continuing operations

   $ 0.79    $ 0.79    $     
 

Discontinued operations

     0.08      0.08          
                          
 

Net earnings attributable to Kraft Foods

   $ 0.87    $ 0.87    $     
                          

 

The following line items within the balance sheets were affected by the change in accounting policy:

 

  

 
       June 30, 2009     
         As Computed
under LIFO
   As Reported under
Average Cost
   Favorable /
(Unfavorable)
     
         (in millions)      
 

Inventories, net

   $ 3,914    $ 4,011    $ (97  
 

Deferred income tax asset

     719      682      37     
 

Retained earnings

     13,956      14,016      60     
       December 31, 2008     
         As Computed
under LIFO
   As Reported under
Average Cost
   Favorable /
(Unfavorable)
     
         (in millions)      
 

Inventories, net

   $ 3,729    $ 3,881    $ (152  
 

Deferred income tax asset

     861      804      57     
 

Retained earnings

     13,345      13,440      95     

 

As a result of the accounting change, retained earnings as of January 1, 2008, increased from $12,209 million, as computed using the LIFO method, to $12,321 million using the average cost method.

 

There was no impact to net cash provided by operating activities as a result of this change in accounting policy.

 

Excise Taxes:

Effective January 1, 2009, we changed our classification of certain excise taxes to a net presentation within cost of sales. In prior years, excise taxes were classified gross within net revenues and cost of sales. With this change, we report all of our excise and similar taxes using the net presentation method. We made this change to better align our net revenues between various countries and to provide better clarity to net revenues and margins. We restated prior years’ financial statements to conform to this change. As a result, we removed $66 million for the three months and $122 million for the six months ended June 30, 2008 from net revenues, and netted the amounts within cost of sales. If we had not made this change, for the three months ended June 30, 2009, net revenues of $10,162 million would have been $10,216 million, and cost of sales of $6,497 million would have been $6,551 million; and for the six months ended June 30, 2009, net revenues of $19,558 million would have been $19,654 million, and cost of sales of $12,628 million would have been $12,724 million. This change did not have a material impact on our net revenues or cost of sales.

 

7


Reclassification:

We changed our cost assignment methodology for headquarter functional costs across our operating structure. As a result, we reclassified $48 million for the three months and $95 million for the six months ended June 30, 2008 from marketing, administration and research costs to cost of sales. This change did not have an impact on net earnings.

Financial Instruments:

Interest rate cash flow and fair value hedges – We manage interest rate volatility by modifying the repricing or maturity characteristics of certain liabilities so that the net interest margin is not, on a material basis, adversely affected by movements in interest rates. As a result of interest rate fluctuations, hedged fixed-rate liabilities appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by our gains or losses on the derivative instruments that are linked to these hedged liabilities.

We use derivative instruments, including interest rate swaps that have indices related to the pricing of specific liabilities as part of our interest rate risk management strategy. As a matter of policy, we do not use highly leveraged derivative instruments for interest rate risk management. Under the interest rate swap contracts, we agree with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts, which is calculated based on an agreed-upon notional amount. We use interest rate swaps to hedge the variability of interest payment cash flows on a portion of our future debt obligations. We also use interest rate swaps to economically convert a portion of our nonprepayable fixed-rate debt into variable rate debt. Substantially all of these derivative instruments are highly effective and qualify for hedge accounting treatment under Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities.

For those derivative instruments that are highly effective and qualify for hedge accounting treatment under SFAS No. 133, we either record the impacts in current period earnings or defer the effective portion of unrealized gains and losses as a component of accumulated other comprehensive earnings / (losses), depending on whether the hedging relationship satisfies the criteria for a fair value or cash flow hedge. For fair value hedges, we record both (i) the gains or losses on interest rate swaps and (ii) the corresponding changes in fair value of the hedged long-term debt directly as a component of interest and other expense, net. For cash flow hedges, we recognize the deferred portion as a component of interest and other expense, net when we incur the interest expense. The ineffective portion is directly recorded as a component of interest and other expense, net. 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 interest and other expense, net.

Refer to our Form 10-K for the year ended December 31, 2008 for information on all other types of financial instruments we use to hedge exposures.

New Accounting Pronouncements:

In September 2006, the Financial Accounting Standards Board (“FASB”) issued 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 deferred 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 adopted the remaining provisions of SFAS No. 157 effective January 1, 2009. This adoption impacts the way that 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, this adoption did not have a material impact on our financial statements.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. Effective January 1, 2009, we adopted the provisions of SFAS No. 141(R), which change the way companies account for business combinations. 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. The adoption of this statement did not have a material impact on our financial statements.

 

8


In December 2007, the FASB also issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements–an amendment of Accounting Research Bulletin No. 51. We adopted the provisions of SFAS No. 160 effective January 1, 2009. This statement required us to classify noncontrolling interests in subsidiaries as a separate component of equity instead of within accrued liabilities. Additionally, transactions between an entity and noncontrolling interests must be treated as equity transactions. Therefore, they no longer are removed from net income, but rather are accounted for as equity. The adoption of this statement did not have a material impact on our financial statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. We adopted the provisions of SFAS No. 161 effective 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, and (iii) how derivative instruments and related hedged items affect our financial results. The adoption of this statement did not have an impact on our financial statements.

 

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

 

In December 2008, the FASB issued FSP FAS No. 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets, which is effective for fiscal years ending after December 15, 2009. FSP FAS No. 132(R)-1 provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. We do not expect the adoption of this statement to have a material impact on our financial statements.

 

In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 requires management to evaluate subsequent events through the date the financial statements are either issued or available to be issued, depending on the company’s expectation of whether it will widely distribute its financial statements to its shareholders and other financial statement users. Companies are required to disclose the date through which subsequent events have been evaluated. We adopted the provisions of SFAS No. 165 effective June 30, 2009.

 

Note 2.  Divestitures:

 

Post Cereals Split-off:

On August 4, 2008, we completed the split-off of the Post cereals business into Ralcorp Holdings, Inc., after an exchange with our shareholders. Accordingly, we restated prior period results to reflect the results of the Post cereals business as discontinued operations on the condensed consolidated statement of earnings. Refer to our Form 10-K for the year ended December 31, 2008 for further details of this transaction.

 

Summary results of operations for the Post cereals business for the three and six months ended June 30, 2008 were as follows:

 

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

Net revenues

   $ 306    $ 576      
                     
 

Earnings before income taxes

     111      196      
 

Provision for income taxes

     42      73      
                     
 

Earnings from discontinued operations,
net of income taxes

   $ 69    $ 123      
                     

 

Other Divestitures:

In the second quarter of 2009, we received $6 million in proceeds and recorded pre-tax losses of $17 million on the divestitures of a juice operation in Brazil and a plant in Spain.

 

9


Note 3.  Inventories:

 

Inventories at June 30, 2009 and December 31, 2008 were:

 

         June 30,
2009
    December 31,
2008
     
       (in millions; 2008 restated)     
 

Raw materials

   $ 1,651      $       1,568     
 

Finished product

     2,360        2,313     
                    
 

Inventories, net

   $ 4,011      $ 3,881     
                    

 

Refer to Note 1, Summary of Significant Accounting Policies, for information on the change in our valuation method for U.S. inventories to the average cost method.

 

Note 4.  Goodwill and Intangible Assets:

 

Goodwill by reportable segment was:

 

         June 30,
2009
    December 31,
2008
     
       (in millions; 2008 restated)     
 

Kraft Foods North America:

      
 

U.S. Beverages

   $ 1,290      $ 1,290     
 

U.S. Cheese

     3,000        3,000     
 

U.S. Convenient Meals

     1,460        1,460     
 

U.S. Grocery

     3,046        3,046     
 

U.S. Snacks

     6,965        6,965     
 

Canada & N.A. Foodservice

     2,328        2,306     
 

Kraft Foods Europe (1)

     6,401        5,893     
 

Kraft Foods Developing Markets

     3,735        3,621     
                    
 

Total goodwill

   $       28,225      $ 27,581     
                    
 

 

(1)    This segment was formerly known as European Union.

 

As discussed in Note 12, Segment Reporting, we implemented changes to our operating structure in 2009. As a result of these changes, we aligned the reporting of our Central Europe operations into our Kraft Foods Developing Markets segment and moved $1,534 million of goodwill from Kraft Foods Europe to Kraft Foods Developing Markets as of January 1, 2009. We restated prior period segment results in a consistent manner.

 

Intangible assets were:

 

         June 30,
2009
    December 31,
2008
     
       (in millions)     
 

Non-amortizable intangible assets

   $ 13,084      $ 12,758     
 

Amortizable intangible assets

     265        254     
                    
       13,349        13,012     
 

Accumulated amortization

     (92     (86  
                    
 

Intangible assets, net

   $ 13,257      $ 12,926     
                    

 

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

 

10


The movements in goodwill and intangible assets were:

 

  

 
         Goodwill     Intangible
Assets, at Cost
           
       (in millions)       
 

Balance at December 31, 2008

   $ 27,581      $ 13,012       
 

Changes due to:

        
 

Foreign currency

     644        343       
 

Other

            (6    
                      
 

Balance at June 30, 2009

   $ 28,225      $       13,349       
                      

 

Amortization expense for intangible assets was $3 million for the three months and $9 million for the six months ended June 30, 2009. We currently estimate amortization expense for each of the next five years to be approximately $20 million or less.

 

Note 5.  Restructuring Costs:

 

2004 – 2008 Restructuring Program:

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

 

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

•      announced the closure of 35 facilities and announced the elimination of approximately 18,800 positions; and

•      will use cash to pay for $2.0 billion of the $3.0 billion in charges.

 

In the second quarter of 2009, we sold a plant in Spain that we previously announced for closure under our Restructuring Program. Accordingly, we reversed $35 million in Restructuring Program charges during the second quarter of 2009, primarily related to severance, and recorded a $17 million loss on the divestiture of the plant. The reversal of the Restructuring Program costs, which affected the segment operating income of the Kraft Foods Europe segment, was recorded within asset impairment and exit costs. Since the inception of the Restructuring Program, we have paid cash for $1.6 billion of the $3.0 billion in charges, including $80 million paid in the first six months of 2009. At June 30, 2009, we had an accrual of $399 million, and we had eliminated approximately 16,000 positions under the Restructuring Program.

 

Restructuring liability activity for the six months ended June 30, 2009 was:

 

         Severance     Other     Total      
         (in millions)      
 

Liability balance, January 1, 2009

   $             444      $ 45      $             489     
 

Reversal of charges

     (32     (3     (35  
 

Cash spent

     (76     (4     (80  
 

Currency

     25               25     
                            
 

Liability balance, June 30, 2009

   $ 361      $ 38      $ 399     
                            

 

Our 2009 activity was related to the aforementioned reversal of $35 million and cash outflows on prior year Restructuring Program charges. Our prior year severance charges included the cost of benefits received by terminated employees. Other prior year costs related primarily to the renegotiation of supplier contract costs, workforce reductions associated with facility closings and the termination of leasing agreements.

 

11


Note 6. Accumulated Other Comprehensive Losses:

 

The components of accumulated other comprehensive losses were:

 

  

  

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

Balances at December 31, 2008

   $            (2,399   $ (3,572   $ (23   $ (5,994
 

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

        
 

Currency translation adjustments

     1,212        (86            1,126   
 

Amortization of experience losses and
prior service costs

            60               60   
 

Settlement losses

            41               41   
 

Net actuarial loss arising during period

            (8            (8
 

Change in fair value of cash flow
hedges

                   52        52   
                
 

Total other comprehensive earnings

           1,271   
                                  
 

Balances at June 30, 2009

   $ (1,187   $             (3,565   $                   29      $           (4,723)   
                                  

 

Note 7.  Stock Plans:

 

At our annual meeting of shareholders held on May 20, 2009, our shareholders approved the Kraft Foods Inc. Amended and Restated 2005 Performance Incentive Plan. The amended plan includes, among other provisions, a limit on the number of shares that may be granted under the plan, vesting restrictions and a prohibition on stock option repricing. Under the amended plan, we are authorized to issue a maximum of 168.0 million shares of our Common Stock. As of the effective date of the amendment, there were 92.1 million shares available to be granted under the plan, of which no more than 27.5 million shares may be awarded as restricted or deferred stock.

 

In January 2009, we granted 1.4 million shares of stock in connection with our long-term incentive plan. The market value per share was $27.00 on the date of grant. The unvested shares have no voting rights and do not pay dividends.

 

In February 2009, as part of our annual incentive program, we issued 4.1 million shares of restricted and deferred stock to eligible U.S. and non-U.S. employees. The market value per restricted or deferred share was $23.64 on the date of grant. Also, as part of our annual incentive program, we granted 16.3 million stock options to eligible U.S. and non-U.S. employees at an exercise price of $23.64.

 

We also issued 0.2 million off-cycle shares of restricted and deferred stock during the first six months of 2009. The weighted-average market value per restricted or deferred share was $24.90 on the date of grant. In aggregate, we issued 5.7 million restricted and deferred shares during the first six months of 2009, including those issued as part of our long-term incentive plan.

 

During the first six months of 2009, 5.2 million shares of restricted and deferred stock vested at a market value of $130 million. There were 3.0 million stock options exercised during the first six months of 2009 with a total intrinsic value of $32 million.

 

12


Note 8.  Benefit Plans:

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, 2009 and 2008:

 

         U.S. Plans     Non-U.S. Plans  
         For the Three Months Ended
June 30,
    For the Three Months Ended
June 30,
 
         2009     2008     2009     2008  
         (in millions)  
 

Service cost

   $        39      $        37      $        15      $        24   
 

Interest cost

     92        93        51        57   
 

Expected return on plan assets

     (121     (131     (58     (74
 

Amortization:

        
 

Net loss from experience differences

     40        22        6        8   
 

Prior service cost

     1        1        2        2   
 

Settlement losses

     40        13                 
                                  
 

Net periodic pension cost

   $ 91      $ 35      $ 16      $ 17   
                                  
         U.S. Plans     Non-U.S. Plans  
         For the Six Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2009     2008     2009     2008  
         (in millions)  
 

Service cost

   $ 78      $ 75      $ 30      $ 47   
 

Interest cost

     184        186        102        113   
 

Expected return on plan assets

     (242     (263     (115     (146
 

Amortization:

        
 

Net loss from experience differences

     79        43        11        15   
 

Prior service cost

     3        3        3        4   
 

Settlement losses

     66        21                 
                                  
 

Net periodic pension cost

   $ 168      $ 65      $ 31      $ 33   
                                  

The following costs are included in settlement losses above. Severance benefits from our cost-savings initiatives and retiring employees who elected lump-sum payments resulted in settlement losses for our U.S. plans of $40 million for the three months and $66 million for the six months ended June 30, 2009, and $13 million for the three months and $21 million for the six months ended June 30, 2008.

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 first six months of 2009, we contributed $219 million to our U.S. plans (including the $200 million contribution we made on May 1, 2009) and $86 million to our non-U.S. plans. Based on current tax law, we plan to make further contributions of approximately $20 million to our U.S. plans and approximately $80 million to our non-U.S. plans during the remainder of 2009. However, our actual contributions may differ due to many factors, including changes in tax and other benefit laws, or significant differences between expected and actual pension asset performance or interest rates.

 

13


Postretirement Benefit Plans

Net postretirement health care costs consisted of the following for the three and six months ended June 30, 2009 and 2008:

 

         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2009     2008     2009     2008  
         (in millions)  
 

Service cost

   $        10      $        10      $        19      $        22   
 

Interest cost

     43        46        87        91   
 

Amortization:

        
 

Net loss from experience
differences

     11        16        22        28   
 

Prior service credit

     (8     (8     (16     (14
                                  
 

Net postretirement health care costs

   $ 56      $ 64      $ 112      $ 127   
                                  

 

Postemployment Benefit Plans

 

Net postemployment costs consisted of the following for the three and six months ended June 30, 2009 and 2008:

 

  

  

         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2009     2008     2009     2008  
         (in millions)  
 

Service cost

   $ 2      $ 1      $ 4      $ 2   
 

Interest cost

            2        3        3   
 

Amortization of net (gains) / losses

     4               3        (1
 

Other (credits) / costs

     (7     64        (7     123   
                                  
 

Net postemployment (credits) / costs

   $ (1   $ 67      $ 3      $ 127   
                                  

The following costs are included in other (credits) / costs above. We incurred $25 million in severance charges in the second quarter of 2009 related to our Kraft Foods Europe Reorganization. We also reversed $32 million in severance charges in the second quarter of 2009 related to our Restructuring Program as we sold a plant in Spain that we previously announced for closure under the program. Additionally, the postemployment 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.

 

Note 9.  Financial Instruments:

 

Fair Value of Derivative Instruments:

The fair values of derivative instruments recorded in the condensed consolidated balance sheet as of June 30, 2009 were:

 

      

  

  

  

         June 30, 2009              
         Asset
Derivatives
    Liability
Derivatives
             
         (in millions)              
 

Derivatives designated as hedging
instruments under SFAS No. 133:

      
 

Foreign exchange contracts

   $ 34      $ 141       
 

Commodity contracts

     16        65       
 

Interest rate contracts

     33        1       
                      
     $ 83      $ 207       
                      
 

Derivatives not designated as hedging
instruments under SFAS No. 133:

        
 

Foreign exchange contracts

   $ 2      $ 6       
 

Commodity contracts

     103        153       
                      
     $ 105      $ 159       
                      
 

Total fair value

   $ 188      $ 366       
                      

 

14


We include the fair value of our asset derivatives within other current assets and the fair value of our liability derivatives within other current liabilities.

The fair values (asset / (liability)) of our derivative instruments at June 30, 2009 were determined 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)
 
         (in millions)  
 

Foreign exchange contracts

   $ (111   $      $ (111   $   
 

Commodity contracts

     (99     (104     5          
 

Interest rate contracts

     32               32          
                                  
 

Total derivatives

   $ (178   $ (104   $ (74   $   
                                  

 

Cash Flow Hedges:

Cash flow 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,
 
         2009     2008     2009     2008  
         (in millions)  
 

Accumulated gain / (loss) at beginning
of period

   $ (5   $ 54      $ (23   $ 27   
 

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

     54        1        89        (2
 

Unrealized gain / (loss) in fair value

     (20     (7     (37     23   
                                  
 

Accumulated gain at June 30

   $ 29      $ 48      $ 29      $ 48   
                                  

 

The effect of cash flow hedges for the three and six months ended June 30, 2009 was (in millions):

 

  

         For the Three Months Ended
June 30, 2009
    For the Six Months Ended
June 30, 2009
 
         Gain / (Loss)
Recognized
in OCI
    (Gain) / Loss
Reclassified
from AOCI
into Earnings
    Gain / (Loss)
Recognized
in OCI
    (Gain) / Loss
Reclassified
from AOCI
into Earnings
 
 

Foreign exchange contracts –
intercompany loans

   $ 1      $      $ 1      $   
 

Foreign exchange contracts –
forecasted transactions

     (38     (5     (23     (27
 

Commodity contracts

     (4     59        (36     116   
 

Interest rate contracts

     21               21          
                                  
 

Total

   $ (20   $ 54      $ (37   $ 89   
                                  

 

15


         Gain / (Loss) on Ineffectiveness
Recognized in Earnings
           
         For the Three
Months Ended
June 30, 2009
    For the Six
Months Ended
June 30, 2009
           
 

Foreign exchange contracts –
intercompany loans

   $      $       
 

Foreign exchange contracts –
forecasted transactions

                  
 

Commodity contracts

     4        2       
 

Interest rate contracts

                  
                      
 

Total

   $ 4      $ 2       
                      

 

We record both (i) the gain or loss reclassified from AOCI into earnings and (ii) the gain or loss on ineffectiveness in:

 

•      cost of sales for commodity contracts;

•      cost of sales or marketing, administration and research costs for foreign exchange contracts related to forecasted transactions, depending on the type of transaction; and

•      interest and other expense, net for foreign exchange contracts related to intercompany loans and interest rate contracts.

 

We expect to transfer unrealized losses of $31 million (net of taxes) for commodity cash flow hedges and unrealized gains of $26 million (net of taxes) for foreign currency cash flow hedges to earnings during the next 12 months. As of June 30, 2009, we had hedged forecasted:

 

•      commodity transactions for periods not exceeding the next 18 months;

•      interest rate transactions for periods not exceeding the next 148 months; and

•      foreign currency transactions for periods not exceeding the next 30 months, and excluding intercompany loans, we had hedged forecasted foreign currency transactions for periods not exceeding the next 12 months.

 

Fair Value Hedges:

The effect of fair value hedges for the three and six months ended June 30, 2009 was (in millions):

 

         For the Three Months Ended
June 30, 2009
    For the Six Months Ended
June 30, 2009
         Gain / (Loss)
Recognized
in Income on
Derivatives
    Gain / (Loss)
Recognized
in Income on
Borrowings
    Gain / (Loss)
Recognized
in Income on
Derivatives
    Gain / (Loss)
Recognized
in Income on
     Borrowings     
 

Interest rate contracts

   $ (1   $ 1      $ (1   $ 1

 

We include the gain or loss on hedged long-term debt and the offsetting loss or gain on the related interest rate swap in interest and other expense, net.

 

Hedges of Net Investments in Foreign Operations:

The effect of hedges of net investments in foreign operations for the three and six months ended June 30, 2009 was (in millions):

 

         Gain / (Loss)
Recognized in OCI
    Location of
Gain / (Loss)
Recorded in
AOCI
     
         For the Three
Months Ended
     June 30, 2009     
    For the Six
Months Ended
     June 30, 2009     
     
 

Euro notes

   $ (143   $ (12    

 
 

Currency

Translation
Adjustment

  

  
  

 

 

 

16


Economic Hedges:

The effect of economic hedges, derivatives that are not designated as hedging instruments under SFAS No. 133, for the three and six months ended June 30, 2009 was (in millions):

 

         Gain / (Loss)
Recognized in Earnings
    Location of
         For the Three
Months Ended
     June 30, 2009     
    For the Six
Months Ended
     June 30, 2009     
    Gain / (Loss)
Recognized

in Earnings
 

Foreign exchange contracts – intercompany
loans and forecasted interest payments

   $ 11      $ (8   Interest expense
 

Foreign exchange contracts –
forecasted transactions

     (7     (6   Cost of sales
 

Commodity contracts

     (10     16      Cost of sales
                    
 

Total

   $ (6   $ 2     
                    

 

We recognized net gains on commodity contracts not designated as hedging instruments 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. See our Form 10-K for the year ended December 31, 2008 for additional information on our purpose for entering into derivatives not designated as hedging instruments and our overall risk management strategies.

 

Volume:

As of June 30, 2009, we had the following outstanding hedges:

 

         Notional
Amount in USD
           
         (in millions)            
 

Foreign exchange contracts –
intercompany loans

   $ 2,205       
 

Foreign exchange contracts –
forecasted transactions

     828       
 

Commodity contracts

     1,885       
 

Interest rate contracts

     1,150       
 

Net investment hedge – euro notes

     3,998       

Note 10.  Commitments and Contingencies:

Legal Proceedings:

We are involved, from time to time, in legal proceedings, claims, and governmental inspections or investigations, arising in the ordinary course of our business. While we cannot predict with certainty the results of these matters, we do not expect that the ultimate costs to resolve these matters will have a material effect on our financial results.

Third-Party Guarantees:

We have third-party guarantees because of our construction activities. As part of those transactions, we guarantee that third parties will make contractual payments or achieve performance measures. At June 30, 2009, the carrying amount of our third-party guarantees on our condensed consolidated balance sheet and the maximum potential payment under these guarantees was $30 million. Substantially all of these guarantees expire at various times through 2018.

 

17


Note 11.  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,
         2009    2008    2009    2008
         (in millions, except per share data; 2008 restated)
 

Earnings from continuing operations

   $ 829    $ 678    $     1,491    $     1,225
 

Earnings from discontinued operations,
net of income taxes

          69           123
                             
 

Net earnings

     829      747      1,491      1,348
 

Noncontrolling interest

     2      2      4      4
                             
 

Net earnings attributable to Kraft Foods

   $ 827    $ 745    $ 1,487    $ 1,344
                             
 

Weighted-average shares for basic EPS

     1,478      1,522      1,476      1,527
 

Plus incremental shares from assumed
conversions of stock options and
long-term incentive plan shares

     6      10      8      11
                             
 

Weighted-average shares for diluted EPS

     1,484      1,532      1,484      1,538
                             
 

Basic earnings per share attributable
to Kraft Foods:

           
 

Continuing operations

   $ 0.56    $ 0.44    $ 1.01    $ 0.80
 

Discontinued operations

          0.05           0.08
                             
 

Net earnings attributable to Kraft Foods

   $ 0.56    $ 0.49    $ 1.01    $ 0.88
                             
 

Diluted earnings per share attributable
to Kraft Foods:

           
 

Continuing operations

   $ 0.56    $ 0.44    $ 1.00    $ 0.79
 

Discontinued operations

          0.05           0.08
                             
 

Net earnings attributable to Kraft Foods

   $ 0.56    $ 0.49    $ 1.00    $ 0.87
                             

We exclude antidilutive Kraft Foods stock options from our calculation of weighted-average shares for diluted EPS. We excluded 23.8 million antidilutive options for the three and six months ended June 30, 2009, and we excluded 0.6 million antidilutive options for the three months and 11.6 million antidilutive options for the six months ended June 30, 2008.

Note 12.  Segment Reporting:

Effective January 2009, we began implementing changes to our operating structure based on our Organizing For Growth initiative and Kraft Foods Europe Reorganization. In line with our strategies, we are reorganizing our European operations to function on a pan-European centralized category management and value chain model, and we changed how we work in Europe in two key ways:

 

   

We transitioned our European Biscuit, Chocolate, Coffee and Cheese categories to fully integrated business units, further strengthening our focus on these core categories. To ensure decisions are made faster and closer to our customers and consumers, each category is fully accountable for its financial results, including marketing, manufacturing and R&D. Category leadership, based in Zurich, Switzerland, reports to the Kraft Foods Europe President. These business units now comprise the Kraft Foods Europe segment.

   

We aligned the reporting of our Central Europe operations into our Kraft Foods Developing Markets segment to help build critical scale in these countries. We operate a country-led model in these markets.

We manufacture and market packaged food products, including snacks, beverages, cheese, convenient meals and various packaged grocery products. We manage and report operating results through three commercial units: Kraft Foods North America, Kraft Foods Europe and Kraft Foods Developing Markets. We manage the operations of Kraft Foods North America and Kraft Foods Europe by product category, and we manage the operations of Kraft Foods Developing Markets by geographic location. Our reportable segments are U.S. Beverages, U.S. Cheese, U.S. Convenient Meals, U.S. Grocery, U.S. Snacks, Canada & North America Foodservice, Kraft Foods Europe (formerly known as European Union) and Kraft Foods Developing Markets.

 

18


Management uses segment operating income to evaluate segment performance and allocate resources. We believe it is appropriate to disclose this measure to help investors analyze segment performance and trends. Segment operating income excludes unrealized gains and losses on hedging activities (which are a component of cost of sales), certain components of our U.S. pension plan cost (which is a component of cost of sales and marketing, administration and research costs), general corporate expenses (which are a component of marketing, administration and research costs) and amortization of intangibles for all periods presented. In 2009, we began excluding certain components of our U.S. pension plan cost from segment operating income because we centrally manage pension plan funding decisions and the determination of discount rate, expected rate of return on plan assets and other actuarial assumptions. Therefore, we allocate only the service cost component of our U.S. pension plan expense to segment operating income. We exclude the unrealized gains and losses on hedging activities from segment operating income in order to provide better transparency of our segment operating results. Once realized, the gains and losses on hedging activities are recorded within segment operating results. Furthermore, we centrally manage interest and other expense, net. Accordingly, we do not present these items by segment because they are excluded from the segment profitability measure that management reviews.

Segment data were:

 

         For the Three Months Ended
June 30,
      For the Six Months Ended   
June 30,
         2009    2008    2009    2008
         (in millions; 2008 restated)
 

Net revenues:

           
 

Kraft Foods North America:

           
 

U.S. Beverages

   $ 836    $ 789    $ 1,619    $ 1,561
 

U.S. Cheese

     887      972      1,781      1,929
 

U.S. Convenient Meals

     1,166      1,089      2,283      2,121
 

U.S. Grocery

     973      912      1,791      1,704
 

U.S. Snacks

     1,288      1,272      2,485      2,462
 

Canada & N.A. Foodservice

     1,027      1,141      1,934      2,170
 

Kraft Foods Europe

     2,083      2,521      4,011      4,901
 

Kraft Foods Developing Markets

     1,902      2,108      3,654      4,002
                             
 

Net revenues

   $ 10,162    $ 10,804    $ 19,558    $ 20,850
                             

 

19


 

         For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
         2009     2008     2009     2008  
         (in millions; 2008 restated)  
 

Earnings from continuing operations
before income taxes:

        
 

Operating income:

        
 

Kraft Foods North America:

        
 

U.S. Beverages

   $ 148      $ 135      $ 310      $ 280   
 

U.S. Cheese

     166        143        297        225   
 

U.S. Convenient Meals

     141        103        282        196   
 

U.S. Grocery

     339        306        601        545   
 

U.S. Snacks

     205        222        334        342   
 

Canada & N.A. Foodservice

     145        131        230        238   
 

Kraft Foods Europe

     208        109        354        233   
 

Kraft Foods Developing Markets

     253        246        460        436   
 

Unrealized gains on hedging activities

     34        78        121        103   
 

Certain U.S. pension plan costs

     (54            (94       
 

General corporate expenses

     (51     (46     (87     (97
 

Amortization of intangibles

     (3     (4     (9     (11
                                  
 

Operating income

     1,531        1,423        2,799        2,490   
 

Interest and other expense, net

     312        331        592        636   
                                  
 

Earnings from continuing operations
before income taxes

   $ 1,219      $         1,092      $         2,207      $         1,854   
                                  

 

Asset Impairment Charges – We recorded a $9 million asset impairment charge to write-off an investment in Norway. The charge was recorded within asset impairment and exit costs within the segment operating income of Kraft Foods Europe.

 

Unrealized Gains on Hedging Activities – We recognized gains on the change in unrealized hedging positions of $34 million for the three months and $121 million for the six months ended June 30, 2009, and $78 million for the three months and $103 million for the six months ended June 30, 2008.

 

Net revenues by consumer sector, which includes Kraft macaroni and cheese dinners in the Convenient Meals sector and the separation of Canada & N.A. Foodservice, and Kraft Foods Europe and Kraft Foods Developing Markets into sector components, were:

 

   

    

    

         For the Three Months Ended June 30, 2009  
         Kraft Foods
North America
    Kraft Foods
Europe
    Kraft Foods
Developing
Markets
    Total  
         (in millions)  
 

Snacks

   $ 1,513      $ 1,076      $ 993      $ 3,582   
 

Beverages

     965        579        537        2,081   
 

Cheese

     1,212        241        198        1,651   
 

Grocery

     950        103        144        1,197   
 

Convenient Meals

     1,537        84        30        1,651   
                                  
 

Total net revenues

   $ 6,177      $ 2,083      $ 1,902      $ 10,162   
                                  

 

20


         For the Three Months Ended June 30, 2008
         Kraft Foods
North America
   Kraft Foods
Europe
   Kraft Foods
Developing
Markets
   Total
         (in millions; as restated)
 

Snacks

   $ 1,507    $ 1,326    $ 1,157    $ 3,990
 

Beverages

     929      678      571      2,178
 

Cheese

     1,361      301      206      1,868
 

Grocery

     936      116      147      1,199
 

Convenient Meals

     1,442      100      27      1,569
                             
 

Total net revenues

   $ 6,175    $         2,521    $         2,108    $       10,804
                             
         For the Six Months Ended June 30, 2009
         Kraft Foods
North America
   Kraft Foods
Europe
   Kraft Foods
Developing
Markets
   Total
         (in millions)
 

Snacks

   $ 2,893    $ 2,136    $ 1,992    $ 7,021
 

Beverages

     1,846      1,104      958      3,908
 

Cheese

     2,419      462      388      3,269
 

Grocery

     1,702      175      260      2,137
 

Convenient Meals

     3,033      134      56      3,223
                             
 

Total net revenues

   $ 11,893    $ 4,011    $ 3,654    $ 19,558
                             
         For the Six Months Ended June 30, 2008
         Kraft Foods
North America
   Kraft Foods
Europe
   Kraft Foods
Developing
Markets
   Total
         (in millions; as restated)
 

Snacks

   $ 2,889    $ 2,625    $ 2,261    $ 7,775
 

Beverages

     1,817      1,314      1,017      4,148
 

Cheese

     2,701      585      407      3,693
 

Grocery

     1,702      201      267      2,170
 

Convenient Meals

     2,838      176      50      3,064
                             
 

Total net revenues

   $ 11,947    $ 4,901    $ 4,002    $ 20,850
                             

Note 13.  Subsequent Events:

In July 2009, we announced our intention to redeem our November 2011, 7% $200 million debenture at par value. Upon early extinguishment of this debenture, we expect to record a loss of approximately $14 million.

We evaluated subsequent events through August 5, 2009 and included all accounting and disclosure requirements related to subsequent events in our financial statements.

 

21


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. We have operations in more than 70 countries and sell our products in approximately 150 countries.

Executive Summary

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

 

   

Net revenues in the second quarter of 2009 decreased 5.9% to $10.2 billion and decreased 6.2% to $19.6 billion in the first six months of 2009 as compared to the same periods in the prior year.

 

   

Diluted EPS in the second quarter of 2009 increased 14.3% to $0.56 and increased 14.9% to $1.00 in the first six months of 2009 as compared to the same periods in the prior year.

 

   

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

 

   

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

Discussion and Analysis

Items Affecting Comparability of Financial Results

Divestitures

Post Cereals Split-off:

On August 4, 2008, we completed the split-off of the Post cereals business into Ralcorp Holdings, Inc., after an exchange with our shareholders. Accordingly, we restated prior period results to reflect the results of the Post cereals business as discontinued operations on the condensed consolidated statement of earnings. Refer to our Form 10-K for the year ended December 31, 2008 for further details of this transaction.

Summary results of operations for the Post cereals business for the three and six months ended June 30, 2008 were as follows:

 

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

Net revenues

   $ 306    $ 576   
                  
 

Earnings before income taxes

     111      196   
 

Provision for income taxes

     42      73   
                  
 

Earnings from discontinued operations,
net of income taxes

   $ 69    $ 123   
                  

Other Divestitures:

In the second quarter of 2009, we received $6 million in proceeds and recorded pre-tax losses of $17 million, or $0.01 per diluted share, on the divestitures of a juice operation in Brazil and a plant in Spain.

During the first six months of 2008, we received $76 million in proceeds and recorded pre-tax losses of $92 million, or $0.04 per diluted share, on the divestitures of several operations in Spain. Separately, we divested a biscuit operation in Spain and a trademark in Hungary that we previously acquired as part of the acquisition of the global LU biscuit business of Groupe Danone S.A. (“LU Biscuit”). Accordingly, we reflected the impacts as adjustments to the purchase price allocations.

 

22


The operating results of these divestitures were not material to our financial statements in any of the periods presented, neither individually nor in the aggregate.

Restructuring Costs

2004 – 2008 Restructuring Program:

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

 

   

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

   

announced the closure of 35 facilities and announced the elimination of approximately 18,800 positions;

   

will use cash to pay for $2.0 billion of the $3.0 billion in charges; and

   

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

In the second quarter of 2009, we sold a plant in Spain that we previously announced for closure under our Restructuring Program. Accordingly, we reversed $35 million in Restructuring Program charges during the second quarter of 2009, primarily related to severance (resulting in a favorable impact to diluted EPS of $0.02), and recorded a $17 million loss on the divestiture of the plant (resulting in an unfavorable impact to diluted EPS of $0.01). The reversal of the Restructuring Program costs, which affected the segment operating income of the Kraft Foods Europe segment, was recorded within asset impairment and exit costs. 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. Since the inception of the Restructuring Program, we have paid cash for $1.6 billion of the $3.0 billion in charges, including $80 million paid in the first six months of 2009. At June 30, 2009, we had an accrual of $399 million, and we had eliminated approximately 16,000 positions under the Restructuring Program.

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. We recorded implementation costs of $18 million during the three months and $36 million during the six months ended June 30, 2008 within cost of sales and marketing, administration and research costs. 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 included the discontinuation of less profitable product lines, incremental expenses related to the closure of facilities, the Electronic Data Systems transition and the reorganization of our European operations. Management believes the disclosure of implementation charges provides readers of our financial statements greater transparency to the total costs of our Restructuring Program.

Provision for Income Taxes

Our effective tax rate was 32.0% in the second quarter of 2009 and 32.4% in the first six months of 2009. Our second quarter 2009 effective tax rate included net tax benefits of $37 million, primarily resulting from the resolution of state tax audits and several items in our international operations. For the first six months of 2009, our effective tax rate included net tax benefits of $62 million, primarily resulting from the resolution of tax audits and outstanding items in our international operations, and corrections of federal, state and foreign deferred taxes in the first quarter.

Our effective tax rate was 37.9% in the second quarter of 2008 and 33.9% in the first six months of 2008. Our effective tax rate included net tax benefits of $13 million in the second quarter of 2008, primarily resulting from the tax impact of the divestiture of an operation in Spain. For the first six months of 2008, our effective tax rate included 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 operations in Spain and the second quarter divestiture discussed above.

 

23


Consolidated Results of Operations

The following discussion compares our consolidated results of operations for the three months ended June 30, 2009 and 2008, and for the six months ended June 30, 2009 and 2008.

Three Months Ended June 30:

         For the Three Months Ended
June 30,
    $ change     % change  
         2009    2008      
        

(in millions, except per

share data; 2008 restated)

             
 

Net revenues

   $       10,162    $       10,804      $             (642               (5.9%
 

Operating income

     1,531      1,423        108      7.6%   
 

Earnings from continuing operations

     829      678        151      22.3%   
 

Net earnings attributable to Kraft Foods

     827      745        82      11.0%   
 

Diluted earnings per share attributable
to Kraft Foods

     0.56      0.49        0.07      14.3%   

 

Net Revenues – Net revenues decreased $642 million (5.9%) to $10,162 million in the second quarter of 2009, due to the following:

  

 

Change in net revenues (by percentage point)

         
 

Unfavorable foreign currency

        (8.1 )pp     
 

Impact of divestitures

        (0.7 )pp     
 

2008 favorable resolution of Brazilian value added
tax claim

        (0.4 )pp     
 

Favorable volume/mix

        0.2  pp     
 

Higher net pricing

        3.1  pp     
                 
 

Total change in net revenues

        (5.9 )%     
                 

Unfavorable foreign currency decreased net revenues by $876 million, due primarily to the strength of the U.S. dollar against the euro, Canadian dollar, Russian ruble, Brazilian real and British pound. The absence of the 2008 favorable resolution of a Brazilian value added tax claim also had an unfavorable impact on revenues. The decrease in net revenues was partially offset by higher input cost-driven pricing and favorable volume/mix. The favorable volume/mix impact on revenue was driven by volume gains in Kraft Foods North America, partially due to the shift of Easter-related shipments into the second quarter, and by favorable mix in Kraft Foods Developing Markets and Kraft Foods Europe. These favorable factors were partially offset by volume declines in Kraft Foods Europe and Kraft Foods Developing Markets, in part due to the discontinuation of less profitable product lines.

 

24


Operating Income – Operating income increased $108 million (7.6%) to $1,531 million in the second quarter of 2009, due to the following:

 

               Operating      
Income
    Change  
         (in millions)     (percentage point)  
 

Operating Income for the Three Months Ended
June 30, 2008 (as restated)

   $ 1,423     
 

Change in operating income

    
 

Higher pricing

     328      20.2  pp 
 

Higher input costs

     (219   (13.6 )pp 
 

Favorable volume/mix

     60      3.7  pp 
 

Lower fixed manufacturing costs

     43      2.6  pp 
 

Higher marketing, administration and research costs

     (79   (4.8 )pp 
 

Lower unrealized gains on hedging activities

     (44   (2.7 )pp 
 

Lower Restructuring Program costs

     156      10.0  pp 
 

Lower losses on divestitures, net

     57      4.2  pp 
 

2008 favorable resolution of Brazilian value added tax claim

     (40   (2.5 )pp 
 

Unfavorable foreign currency

     (132   (8.2 )pp 
 

Other, net

     (22   (1.3 )pp 
                
 

Total change in operating income

     108      7.6
                
 

Operating Income for the Three Months Ended June 30, 2009

   $ 1,531     
            

Higher pricing more than offset our input cost increases during the quarter, as we recovered some of our cumulative cost increases from prior years. The increase in input costs was primarily related to higher raw material costs (including lower realized gains from certain commodity hedging activities). Total marketing, administration and research costs, as recorded in the condensed consolidated statement of earnings, decreased $124 million over the second quarter of 2008, but excluding the impacts of divestitures, foreign currency and prior year Restructuring Program costs, increased $79 million over the second quarter of 2008, primarily due to further investments in our brands. We recognized gains of $34 million on the change in unrealized hedging positions in the second quarter of 2009 and gains of $78 million in the second quarter of 2008. During the second quarter of 2009, we reversed $35 million in Restructuring Program charges recorded in the prior year, versus the $121 million in Restructuring Program charges recognized in the second quarter of 2008. We recorded $17 million of net losses on divestitures in the second quarter of 2009, versus $74 million of net losses on divestitures that were recorded in the second quarter of 2008. In addition, unfavorable foreign currency decreased operating income by $132 million, due primarily to the strength of the U.S. dollar against the euro, Canadian dollar, British pound and Brazilian real.

 

25


Net Earnings and Earnings per Share Attributable to Kraft Foods – Net earnings attributable to Kraft Foods of $827 million increased by $82 million (11.0%) in the second quarter of 2009. Diluted earnings per share attributable to Kraft Foods were $0.56 in the second quarter of 2009, up 14.3% from $0.49 in the second quarter of 2008, due to the following:

 

                    Net Earnings
Attributable to
Kraft Foods
    Diluted EPS
Attributable to
Kraft Foods
 
                   

(in millions, except

per share data)

 
 

Net Earnings Attributable to Kraft Foods for the Three
Months Ended June 30, 2008 (as restated)

     $ 745      $ 0.49   
 

Change in net earnings attributable to Kraft Foods

      
 

Operating gains

            0.05   
 

Lower unrealized gains on hedging activities

            (0.02
 

Lower Restructuring Program costs

         0.07   
 

Lower losses on divestitures, net

            0.03   
 

2008 favorable resolution of Brazilian value added tax claim

         (0.02
 

Lower interest and other expense, net

            0.01   
 

Unfavorable foreign currency

            (0.06
 

Other changes in taxes

            0.04   
                 
 

Change in net earnings from continuing operations

         0.10   
 

Decreased earnings from discontinued operations

         (0.05
                 
 

Change in net earnings from discontinued operations

         (0.05
 

Fewer shares outstanding

            0.02   
                 
 

Total change in net earnings attributable to Kraft Foods

       82        0.07   
                       
 

Net Earnings Attributable to Kraft Foods for the Three
Months Ended June 30, 2009

     $ 827      $ 0.56   
                       
Six Months Ended June 30:          
         For the Six Months Ended
June 30,
    $ change     % change  
         2009    2008      
        

(in millions, except per

share data; 2008 restated)

             
 

Net revenues

   $       19,558    $       20,850      $ (1,292     (6.2%
 

Operating income

     2,799      2,490        309        12.4%   
 

Earnings from continuing operations

     1,491      1,225        266        21.7%   
 

Net earnings attributable to Kraft Foods

     1,487      1,344        143        10.6%   
 

Diluted earnings per share attributable
to Kraft Foods

     1.00      0.87        0.13        14.9%   
Net Revenues – Net revenues decreased $1,292 million (6.2%) to $19,558 million in the first six months of 2009, due to the following:    
 

Change in net revenues (by percentage point)

         
 

Unfavorable foreign currency

        (8.0 )pp     
 

Unfavorable volume/mix

        (1.5 )pp     
 

Impact of divestitures

        (0.8 )pp     
 

2008 favorable resolution of Brazilian value added
tax claim

     (0.3 )pp     
 

Higher net pricing

        4.4  pp     
                 
 

Total change in net revenues

        (6.2) %     
                 

 

26


Unfavorable foreign currency decreased net revenues by $1,659 million, due primarily to the strength of the U.S. dollar against the euro, Canadian dollar, Brazilian real, Russian ruble and British pound. The unfavorable volume/mix impact on revenue was driven by volume declines across all reportable segments, except U.S. Beverages and U.S. Convenient Meals, primarily due to the discontinuation of less profitable product lines and by unfavorable mix in Kraft Foods North America. The absence of the 2008 favorable resolution of a Brazilian value added tax claim also had an unfavorable impact on revenues. The decrease in net revenues was partially offset by higher input cost-driven pricing.

 

Operating Income – Operating income increased $309 million (12.4%) to $2,799 million in the first six months of 2009, due to the following:

 

             Operating    
Income
    Change      
         (in millions)     (percentage point)      
 

Operating Income for the Six Months Ended
June 30, 2008 (as restated)

   $ 2,490       
 

Change in operating income

      
 

Higher pricing

     900      32.0  pp   
 

Higher input costs

     (552   (19.5 )pp   
 

Lower fixed manufacturing costs

     68      2.4  pp   
 

Unfavorable volume/mix

     (30   (1.1 )pp   
 

Higher unrealized gains on hedging activities

     18      0.7  pp   
 

Higher marketing, administration and research costs

     (99   (3.5 )pp   
 

Lower Restructuring Program costs

     254      9.9  pp   
 

Lower losses on divestitures, net

     75      3.4  pp   
 

2008 favorable resolution of Brazilian value added tax claim

     (43   (1.5 )pp   
 

Unfavorable foreign currency

     (254   (9.2 )pp   
 

Other, net

     (28   (1.2 )pp   
                  
 

Total change in operating income

     309      12.4  
                  
 

Operating Income for the Six Months Ended June 30, 2009

   $             2,799       
              

 

Higher pricing more than offset our input cost increases during the first six months of 2009, as we recovered some of our cumulative cost increases from prior years. The increase in input costs was primarily related to higher raw material costs (including lower realized gains from certain commodity hedging activities). Total marketing, administration and research costs, as recorded in the condensed consolidated statement of earnings, decreased $262 million over the first six months of 2008, but excluding the impacts of divestitures, foreign currency and prior year Restructuring Program costs, increased $99 million over the first six months of 2008, primarily due to further investments in our brands. We recognized gains of $121 million on the change in unrealized hedging positions in the first six months of 2009 and gains of $103 million in the first six months of 2008. During the second quarter of 2009, we reversed $35 million in Restructuring Program charges recorded in the prior year, versus the $219 million in Restructuring Program charges recognized in the first six months of 2008. We recorded $17 million of net losses on divestitures in the first six months of 2009, versus $92 million of net losses on divestitures that were recorded in the first six months of 2008. In addition, unfavorable foreign currency decreased operating income by $254 million, due primarily to the strength of the U.S. dollar against the euro, Canadian dollar, British pound and Brazilian real.

 

27


Net Earnings and Earnings per Share Attributable to Kraft Foods – Net earnings attributable to Kraft Foods of $1,487 million increased by $143 million (10.6%) in the first six months of 2009. Diluted earnings per share attributable to Kraft Foods were $1.00 in the first six months of 2009, up 14.9% from $0.87 in the first six months of 2008, due to the following:

 

         Net Earnings
Attributable to
Kraft Foods
   Diluted EPS
Attributable to
Kraft Foods
     
        

(in millions, except

per share data)

     
 

Net Earnings Attributable to Kraft Foods for the Six
Months Ended June 30, 2008 (as restated)

   $ 1,344    $ 0.87     
 

Change in net earnings attributable to Kraft Foods

       
 

Operating gains

        0.10     
 

Higher unrealized gains on hedging activities

        0.01     
 

Lower Restructuring Program costs

        0.11     
 

Lower losses on divestitures, net

        0.03     
 

2008 favorable resolution of Brazilian value added tax claim

        (0.02  
 

Lower interest and other expense, net

        0.02     
 

Unfavorable foreign currency

        (0.11  
 

Other change