Form 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

(Mark One)   
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   For the quarterly period ended September 30, 2010
   OR
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   For the transition period from                      to                     

Commission file number 1-16483

LOGO

Kraft Foods Inc.

(Exact name of registrant as specified in its charter)

 

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

Three Lakes Drive,

Northfield, Illinois

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

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

Not Applicable

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

Indicate by check mark whether the registrant 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 October 29, 2010, there were 1,746,773,569 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 Nine Months Ended September 30, 2010 and 2009

     1   
 

Condensed Consolidated Balance Sheets at
September 30, 2010 and December 31, 2009

     2   
 

Condensed Consolidated Statements of Equity
for the Year Ended December 31, 2009 and the
Nine Months Ended September 30, 2010

     3   
 

Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2010 and 2009

     4   
 

Notes to Condensed Consolidated Financial Statements

     5   

Item 2.

 

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

     28   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     52   

Item 4.

 

Controls and Procedures

     52   

PART II –

 

OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

     53   

Item 1A.

 

Risk Factors

     53   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     54   

Item 6.

 

Exhibits

     54   

Signature

       55   

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
September 30,
     For the Nine Months Ended
September 30,
 
     2010     2009      2010     2009  

Net revenues

   $ 11,863      $   9,397       $   35,434      $   28,157   

Cost of sales

     7,542        6,019         22,330        18,167   
                                 

Gross profit

     4,321        3,378         13,104        9,990   

Selling, general and administrative expenses

     2,758        2,033         8,541        6,014   

Asset impairment and exit costs

     (9             (9     (26

Losses on divestitures, net

                           17   

Amortization of intangibles

     53        6         146        15   
                                 

Operating income

     1,519        1,339         4,426        3,970   

Interest and other expenses, net

     433        323         1,496        915   
                                 

Earnings from continuing operations
before income taxes

     1,086        1,016         2,930        3,055   

Provision for income taxes

     326        242         982        897   
                                 

Earnings from continuing operations

     760        774         1,948        2,158   

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

            52         1,644        159   
                                 

Net earnings

     760        826         3,592        2,317   

Noncontrolling interest

     6        2         18        6   
                                 

Net earnings attributable to Kraft Foods

   $ 754      $ 824       $ 3,574      $ 2,311   
                                 

Per share data:

         

Basic earnings per share attributable to
Kraft Foods:

         

Continuing operations

   $ 0.43      $ 0.52       $ 1.13      $ 1.45   

Discontinued operations

            0.04         0.97        0.11   
                                 

Net earnings attributable to Kraft Foods

   $ 0.43      $ 0.56       $ 2.10      $ 1.56   
                                 

Diluted earnings per share attributable to
Kraft Foods:

         

Continuing operations

   $ 0.43      $ 0.52       $ 1.13      $ 1.45   

Discontinued operations

            0.03         0.96        0.11   
                                 

Net earnings attributable to Kraft Foods

   $ 0.43      $ 0.55       $ 2.09      $ 1.56   
                                 

Dividends declared

   $ 0.29      $ 0.29       $ 0.87      $ 0.87   
                                 

See notes to condensed consolidated financial statements.

 

1


 

Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in millions of dollars)

(Unaudited)

 

     September 30,
2010
    December 31,
2009
 

ASSETS

    

Cash and cash equivalents

   $ 2,288      $ 2,101   

Receivables (less allowances of $183 in 2010 and $121 in 2009)

     6,013        5,197   

Inventories, net

     5,735        3,775   

Deferred income taxes

     901        730   

Other current assets

     887        651   
                

Total current assets

     15,824        12,454   

Property, plant and equipment, net

     13,710        10,693   

Goodwill

     36,764        28,764   

Intangible assets, net

     25,476        13,429   

Prepaid pension assets

     195        115   

Other assets

     1,651        1,259   
                

TOTAL ASSETS

   $ 93,620      $ 66,714   
                

LIABILITIES

    

Short-term borrowings

   $ 331      $ 453   

Current portion of long-term debt

     133        513   

Accounts payable

     5,130        3,766   

Accrued marketing

     1,947        2,181   

Accrued employment costs

     1,197        1,175   

Other current liabilities

     4,888        3,403   
                

Total current liabilities

     13,626        11,491   

Long-term debt

     29,571        18,024   

Deferred income taxes

     6,992        4,508   

Accrued pension costs

     2,424        1,765   

Accrued postretirement health care costs

     2,910        2,816   

Other liabilities

     3,115        2,138   
                

TOTAL LIABILITIES

     58,638        40,742   

Contingencies (Note 13)

    

EQUITY

    

Common Stock, no par value (1,996,537,778 shares issued
in 2010 and 1,735,000,000 shares issued in 2009)

              

Additional paid-in capital

     31,181        23,611   

Retained earnings

     16,621        14,636   

Accumulated other comprehensive losses

     (4,720     (3,955

Treasury stock, at cost

     (8,202     (8,416
                

Total Kraft Foods Shareholders’ Equity

     34,880        25,876   

Noncontrolling interest

     102        96   
                

TOTAL EQUITY

     34,982        25,972   
                

TOTAL LIABILITIES AND EQUITY

   $ 93,620      $ 66,714   
                

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, 2009

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

Comprehensive earnings:

                    

Net earnings

                     3,021                         7         3,028   

Other comprehensive earnings, net
of income taxes

                             2,039                 34         2,073   
                                

Total comprehensive earnings *

                    41         5,101   
                                

Exercise of stock options and issuance of other stock awards

             49         (110              298                 237   

Cash dividends declared
($1.16 per share)

                     (1,715                              (1,715

Dividends paid on noncontrolling interest and other activities

             (1                              (6      (7
                                                              

Balances at December 31, 2009

   $                    –       $           23,611       $ 14,636       $ (3,955    $ (8,416    $ 96       $ 25,972   

Comprehensive earnings / (losses):

                    

Net earnings

                     3,574                         18         3,592   

Other comprehensive losses, net
of income taxes

                             (765              (20      (785
                                

Total comprehensive earnings /
(losses) *

                    (2      2,807   
                                

Exercise of stock options and
issuance of other stock awards

             102         (70              214                 246   

Cash dividends declared
($0.87 per share)

                     (1,519                              (1,519

Net impact of noncontrolling
interests from Cadbury acquisition

             38                                 33         71   

Purchase from noncontrolling
interest, dividends paid and other
activities

             (27                              (25      (52

Issuance of Common Stock

             7,457                                         7,457   
                                                              

Balances at September 30, 2010

   $       $           31,181       $           16,621       $ (4,720    $        (8,202    $             102       $          34,982   
                                                              

 

* Total comprehensive earnings / (losses) were $2,008 million for the quarter ended and $2,807 million for the nine months ended September 30, 2010, as compared to $1,197 million for the quarter ended and $3,981 million for the nine months ended September 30, 2009. Comprehensive earnings / (losses) attributable to Kraft Foods were $1,993 million for the quarter ended and $2,809 million for the nine months ended September 30, 2010, as compared to $1,192 million for the quarter ended and $3,950 million for the nine months ended September 30, 2009.

See notes to condensed consolidated financial statements.

 

3


 

Kraft Foods Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in millions of dollars)

(Unaudited)

 

     For the Nine Months Ended
September 30,
 
     2010     2009  

CASH PROVIDED BY / (USED IN) OPERATING ACTIVITIES

    

Net earnings

   $ 3,592      $ 2,317   

Adjustments to reconcile net earnings to operating cash flows:

    

Depreciation and amortization

     1,019        659   

Stock-based compensation expense

     132        123   

Deferred income tax provision

     127        127   

Losses on divestitures, net

            17   

Gain on discontinued operations (Note 2)

     (1,596       

Asset impairment and exit costs, net of cash paid

            9   

Other non-cash expense, net

     4        189   

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

    

Receivables, net

     264        410   

Inventories, net

     (870     (27

Accounts payable

     (181     (351

Other current assets

     (44     233   

Other current liabilities

     (1,383     (363

Change in pension and postretirement assets and liabilities, net

     160        (74
                

Net cash provided by operating activities

     1,224        3,269   
                

CASH PROVIDED BY / (USED IN) INVESTING ACTIVITIES

    

Capital expenditures

     (1,020     (749

Acquisitions, net of cash received

     (9,843       

Proceeds from divestitures

     4,039        6   

Other

     13        43   
                

Net cash used in investing activities

     (6,811     (700
                

CASH PROVIDED BY / (USED IN) FINANCING ACTIVITIES

    

Net (repayments) / issuance of short-term borrowings

     (1,285     461   

Long-term debt proceeds

     9,438        2   

Long-term debt repaid

     (512     (215

Dividends paid

     (1,664     (1,284

Other

     (89     75   
                

Net cash provided by / (used in) financing activities

     5,888        (961
                

Effect of exchange rate changes on cash and cash equivalents

     (114     144   
                

Cash and cash equivalents:

    

Increase

     187        1,752   

Balance at beginning of period

     2,101        1,244   
                

Balance at end of period

   $       2,288      $       2,996   
                

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 (“U.S. GAAP”). 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, 2009.

Principles of Consolidation:

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

In the second quarter of 2010, we changed the consolidation date for certain European Biscuits operations, which are included within our Kraft Foods Europe segment, and certain operations in Asia Pacific, which are included within our Kraft Foods Developing Markets segment. Previously, these operations primarily reported period-end results one month prior to the end of the quarter and now report period-end results two weeks prior to the last Saturday of the quarter. We believe the change is preferable and will improve financial reporting by better matching the close dates of each subsidiary to our other international operating subsidiaries, which operate similarly. This change resulted in a favorable impact to net revenues of approximately $70 million during the second quarter of 2010 and had an insignificant impact on net earnings in that quarter and on the year. As the impacts to prior period results were not material to our financial results, we have not revised the prior period results for this change. Our domestic operating subsidiaries will continue to report period-end results as of the Saturday closest to the end of each period, and our international operating subsidiaries will continue to report period-end results two weeks prior to the Saturday closest to the end of each period.

Highly Inflationary Accounting:

In the fourth quarter of 2009, the Venezuelan economy was classified as highly inflationary under U.S. GAAP. Effective January 1, 2010, we are accounting for our Venezuelan subsidiaries under highly inflationary accounting rules, which principally means all transactions are recorded in U.S. dollars. Venezuela has three exchange rates: the official rate, the consumer staples rate and the secondary (or parallel) rate. We used both the official rate and the secondary rate to translate our Venezuelan operations into U.S. dollars, based on the nature of the operations of each individual subsidiary. Additionally, we previously carried cash that we had exchanged into U.S. dollars using the secondary market at that rate. Upon the change to highly inflationary accounting, we were then required to translate those U.S. dollars on hand using the official rate, which resulted in a charge of $34 million in the first quarter of 2010.

On January 8, 2010, the Venezuelan government devalued its currency. Accordingly, we were required to revalue our net assets in Venezuela. Through the first nine months of 2010, we recorded approximately $85 million of unfavorable foreign currency impacts relating to highly inflationary accounting in Venezuela (which included the one-time impact to translate cash of $34 million).

 

5


 

New Accounting Pronouncements:

In June 2009, new guidance was issued on the consolidation of variable interest entities. We adopted the guidance effective January 1, 2010. This guidance increases the likelihood of an enterprise being classified as a variable interest entity. The adoption of this guidance did not have a material impact on our financial results.

Note 2.  Acquisitions and Divestitures:

Cadbury Acquisition:

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

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

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

As part of our Cadbury acquisition, we expensed and incurred transaction related fees of $2 million for the three months, $217 million for the nine months ended September 30, 2010 and $11 million for the three and nine months ended September 30, 2009. We recorded these expenses within selling, general and administrative expenses. We also incurred acquisition financing fees of $96 million in the first quarter of 2010. We recorded these expenses within interest and other expense, net.

Cadbury contributed net revenues of $6,376 million and net earnings of $369 million from February 2, 2010 through September 30, 2010. The following unaudited pro forma summary presents Kraft Foods’ consolidated information as if Cadbury had been acquired on January 1, 2009. These amounts were calculated after conversion to U.S. GAAP, applying our accounting policies, and adjusting Cadbury’s results to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant and equipment, and intangible assets had been applied from January 1, 2009, together with the consequential tax effects. These adjustments also reflect the additional interest expense incurred on the debt to finance the purchase, and the divestitures of certain Cadbury confectionery operations in Poland and Romania, as required by the EU Commission as a condition of our Cadbury acquisition.

 

         Pro forma for the
Three  Months
Ended September 30,
     Pro forma for the Nine
Months Ended September 30,
 
         2009      2010      2009  
         (in millions)  
 

Net revenues

   $ 11,812       $               35,997       $               34,599   
 

Net earnings attributable to Kraft Foods

     725         3,420         2,097   

 

6


 

Our February 2, 2010 Cadbury acquisition was valued at $18,547 million, or $17,500 million net of cash and cash equivalents. As part of that acquisition, we acquired the following assets and assumed the following liabilities (in millions):

 

 

Receivables (1)

   $          1,331     
 

Inventories

     1,298     
 

Other current assets

     695     
 

Property, plant and equipment

     3,312     
 

Goodwill (2)

     9,174     
 

Intangible assets (3)

     12,769     
 

Other assets

     376     
 

Short-term borrowings

     (1,206  
 

Accounts payable

     (1,689  
 

Other current liabilities (4)

     (1,711  
 

Long-term debt

     (2,436  
 

Deferred income taxes

     (2,583  
 

Accrued pension costs

     (816  
 

Other liabilities

     (981  
 

Noncontrolling interest

     (33  

 

  (1)      The gross amount due under the receivables we acquired is $1,402 million, of which $71 million is expected to be uncollectable.
  (2)      Goodwill will not be deductible for statutory tax purposes and is attributable to Cadbury’s workforce and the significant synergies we expect from the acquisition.
  (3)      $10.2 billion of the intangible assets acquired are expected to be indefinite lived.
  (4)      Within other current liabilities, a reserve for exposures related to taxes of approximately $70 million was established within our Developing Markets segment. The cumulative exposure was approximately $140 million at September 30, 2010.

The above amounts represent the allocation of purchase price and are substantially complete. We expect to finalize the purchase price allocations during the fourth quarter of 2010.

Pizza Divestiture:

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

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

 

7


 

Summary results of operations for the Frozen Pizza business through September 30, 2010 were:

 

          For the Three 
Months Ended
    For the Nine Months Ended      
          September 30, 
2009
    September 30,
2010
    September 30,
2009
     
         (in millions)      
 

Net revenues

   $ 406      $             335      $           1,204     
                            
 

Earnings before income taxes

     80        73        248     
 

Provision for income taxes

     (28     (25     (89  
 

Gain on discontinued operations, net of
income taxes

            1,596            
                            
 

Earnings and gain from discontinued
operations, net of income taxes

   $ 52      $ 1,644      $ 159     
                            
Earnings before income taxes as presented exclude associated allocated overheads of $25 million for the nine months ended September 30, 2010, $28 million for the three months ended September 30, 2009 and $81 million for the nine months ended September 30, 2009.
The 2010 gain on discontinued operations from the sale of the Frozen Pizza business included tax expense of $1.2 billion.
The following assets of the Frozen Pizza business were included in the Frozen Pizza divestiture (in millions):
 
  Inventories, net    $ 102         
 

Property, plant and equipment, net

     317         
 

Goodwill

     475         
                
 

Distributed assets of the Frozen
Pizza business

   $ 894         
                
Other Divestitures:     
The EU Commission required, as a condition of our Cadbury acquisition, that we divest certain Cadbury confectionery operations in Poland and Romania. In the third quarter of 2010, we completed the sale of the assets of the confectionery operations in Poland and Romania. The total proceeds from the divestitures were $342 million and the impacts of these divestitures were reflected as adjustments to the purchase price allocations.
Note 3. Inventories:     
Inventories at September 30, 2010 and December 31, 2009 were:     
         September 30,
2010
    December 31,
2009
           
         (in millions)            
 

Raw materials

   $ 1,861      $ 1,410       
 

Finished product

     3,874        2,365       
                      
 

Inventories, net

   $ 5,735      $ 3,775       
                      

 

8


 

Note 4.  Property, Plant and Equipment:

Property, plant and equipment at September 30, 2010 and December 31, 2009 were:

 

         September 30,
2010
    December 31,
2009
                     
         (in millions)                      
 

Land and land improvements

   $ 755      $ 492           
 

Buildings and building equipment

     4,690        4,231           
 

Machinery and equipment

     15,811        13,872           
 

Construction in progress

     1,388        828           
                          
       22,644        19,423           
 

Accumulated depreciation

     (8,934     (8,730        
                          
 

Property, plant and equipment, net

   $          13,710      $          10,693           
                          

Note 5.  Goodwill and Intangible Assets:

Goodwill by reportable segment at September 30, 2010 and December 31, 2009 was:

 

         September 30,
2010
     December 31,
2009
                      
         (in millions)                       
 

Kraft Foods North America:

              
 

U.S. Beverages

   $ 1,290       $ 1,290            
 

U.S. Cheese

     3,000         3,000            
 

U.S. Convenient Meals

     985         1,460            
 

U.S. Grocery

     3,046         3,046            
 

U.S. Snacks

     9,056         6,948            
 

Canada & N.A. Foodservice

     3,302         2,340            
 

Kraft Foods Europe

     8,708         6,756            
 

Kraft Foods Developing Markets

     7,377         3,924            
                            
 

Total goodwill

   $          36,764       $         28,764            
                            

Intangible assets at September 30, 2010 and December 31, 2009 were:

 

         September 30,
2010
    December 31,
2009
                     
         (in millions)                      
 

Non-amortizable intangible assets

   $ 22,873      $ 13,262           
 

Amortizable intangible assets

     2,860        278           
                          
       25,733        13,540           
 

Accumulated amortization

     (257     (111        
                          
 

Intangible assets, net

   $          25,476      $         13,429           
                          

Non-amortizable intangible assets consist substantially of brand names purchased through our acquisitions of Nabisco Holdings Corp., the Spanish and Portuguese operations of United Biscuits, the global LU biscuit business of Groupe Danone S.A. and Cadbury. Amortizable intangible assets consist primarily of trademark licenses, customer-related intangibles, process technology and non-compete agreements. At September 30, 2010, the weighted-average life of our amortizable intangible assets was 13.0 years.

 

9


 

The movements in goodwill and intangible assets were:

 

         Goodwill     Intangible
 Assets, at Cost 
            
         (in millions)             
 

Balance at January 1, 2010

   $ 28,764      $ 13,540        
 

Changes due to:

         
 

Foreign currency

     (699     (538     
 

Acquisitions

     9,174        12,769        
 

Divestitures

     (475     (38     
                       
 

Balance at September 30, 2010

   $         36,764      $ 25,733        
                       

Changes to goodwill and intangible assets during the nine months ended September 30, 2010 were:

 

   

Acquisitions – We increased goodwill by $9,174 million and intangible assets by $12,769 million related to allocations of purchase price for our Cadbury acquisition, including the third quarter impacts of our refinements to preliminary allocations, which are substantially complete; however, these allocations are subject to revision upon their finalization in the fourth quarter of 2010. We recorded $2,108 million of the acquired goodwill in our U.S. Snacks segment, $903 million in our Canada & N.A. Foodservice segment, $2,541 million in our Kraft Foods Europe segment and $3,622 million in our Kraft Foods Developing Markets segment.

   

Divestitures – We reduced goodwill by $475 million due to our Frozen Pizza business divestiture.

Amortization expense was $53 million for the three months and $146 million for the nine months ended September 30, 2010. We currently estimate amortization expense for each of the next five years to be approximately $210 million, including the estimated impact of our Cadbury acquisition. Our estimated amortization is subject to revision when appraisals are finalized for our Cadbury acquisition.

Note 6.  Restructuring Costs:

Integration Program:

We believe our combination with Cadbury has the potential for meaningful revenue synergies over time from investments in distribution, marketing and product development. In order to achieve these synergies and cost savings, we expect to incur total integration charges of approximately $1.5 billion in the first three years following the acquisition to combine and integrate the two businesses (the “Integration Program”).

Integration Program costs include the costs associated with combining our operations with Cadbury’s and are separate from the costs related to the acquisition. We incurred charges under the Integration Program of $92 million for the three months and $284 million for the nine months ended September 30, 2010. We recorded these charges in operations, primarily as a part of selling, general and administrative expenses within our Kraft Foods Europe and Kraft Foods Developing Markets segments, as well as general corporate expenses.

During the second quarter of 2010, we evaluated Cadbury’s Vision into Action (“VIA”) restructuring program and began managing it within our overall Integration Program. Cadbury initiated the VIA restructuring program in 2007 and planned to run it through 2011. Accordingly, we acquired an accrual of $248 million relating to charges taken in previous periods. In evaluating their program as part of our corporate strategies and our integration plans, we included the remaining charges within our overall Integration Program. As we move forward on a combined company basis, we do not intend to manage these programs separately.

 

10


 

Liability activity for Integration Program in the first nine months of 2010 was (in millions):

 

  Liability assumed upon acquisition    $  248           
 

Charges

     284           
 

Cash spent

     (286        
 

Write–offs

     (8        
 

Currency / other

     (9        
                  
 

Liability balance, September 30, 2010

   $     229           
                  

Cost Savings Initiatives:

Cost savings initiatives generally include exit, disposal and other project savings costs. We incurred charges associated with our cost savings initiatives of $17 million for the three months and $93 million for the nine months ended September 30, 2010. We recorded these charges in operations, primarily within selling, general and administrative expenses within our Kraft Foods Europe and Canada & N.A. Foodservice segments, as well as general corporate expenses. These charges primarily included other project savings costs associated with the Kraft Foods Europe Reorganization. Even though other project savings costs were directly attributable to exit and disposal costs, they did not qualify for special accounting treatment as exit or disposal activities.

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 the elimination of approximately 18,600 positions; and

   

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

Since the inception of the Restructuring Program, we have paid cash for $1.7 billion of the $2.0 billion in expected cash payments, including $60 million paid in the first nine months of 2010.

Restructuring liability activity for the nine months ended September 30, 2010 was (in millions):

 

  Liability balance, January 1, 2010    $  270           
 

Reversal of charges

     (9        
 

Cash spent

     (60        
 

Currency

     (24        
                  
  Liability balance, September 30, 2010    $     177           
                  

Our 2010 activity was related to cash outflows on prior year Restructuring Program charges and reversals relating to severance benefits and other charges. Our prior year charges to the liability included severance benefits received by terminated employees, other costs related primarily to the renegotiation of supplier contract costs, workforce reductions associated with facility closings and the termination of leasing agreements.

 

11


 

Note 7.  Debt:

Short-Term Borrowings:

At September 30, 2010 and December 31, 2009, our short-term borrowings and related weighted-average interest rates consisted of:

 

         September 30, 2010      December 31, 2009  
         Amount
Outstanding
     Weighted-
Average Rate
     Amount
Outstanding
     Weighted-
Average Rate
 
         (in millions)             (in millions)         
 

Commercial paper

   $               $ 262         0.5%   
 

Bank loans

     331         6.4%         191         10.5%   
                         
 

Total short-term borrowings

   $ 331          $ 453      
                         

The fair values of our short-term borrowings at September 30, 2010 and December 31, 2009, based upon current market interest rates, approximate the amounts disclosed above.

Borrowing Arrangements:

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

The revolving credit facility agreement includes a covenant that we maintain a minimum total shareholders’ equity, excluding accumulated other comprehensive earnings / (losses), of at least $28.6 billion. This threshold was increased by $5.6 billion to $28.6 billion due to the equity we issued as part of our Cadbury acquisition. At September 30, 2010, our total shareholders’ equity, excluding accumulated other comprehensive earnings / (losses), was $39.6 billion. We expect to continue to meet this covenant. The revolving credit facility agreement also contains customary representations, covenants and events of default. However, there are no other financial covenants, credit rating triggers or provisions that could require us to post collateral as security.

In addition to the above, some of our international subsidiaries maintain primarily uncommitted credit lines to meet short-term working capital needs. Collectively, these credit lines amounted to $2.5 billion at September 30, 2010. Borrowings on these lines amounted to $331 million at September 30, 2010 and $191 million at December 31, 2009.

Cadbury maintained a three-year, £450 million senior unsecured revolving credit facility that we terminated effective June 30, 2010.

As part of our Cadbury acquisition, on November 9, 2009, we entered into an agreement for a 364-day senior unsecured bridge facility (the “Cadbury Bridge Facility”). During the first quarter of 2010, we borrowed £807 million under the Cadbury Bridge Facility, and later repaid it ($1,205 million at the time of repayment) with proceeds from the divestiture of our Frozen Pizza business. Upon repayment, the Cadbury Bridge Facility was terminated.

Long-Term Debt:

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

 

   

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

   

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

   

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

   

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

 

12


 

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

 

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

The fair value of the long-term debt we acquired as part of our Cadbury acquisition was $2,436 million at February 2, 2010. The acquired debt has the following terms:

 

   

£77 million (approximately $121 million) total principal notes due December 10, 2010 at a fixed, annual interest rate of 4.875%.

   

C$150 million (approximately $146 million) Canadian bank loan agreement expiring August 30, 2012 at a variable interest rate. The interest rate at September 30, 2010 was 1.153%.

   

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

   

£300 million (approximately $471 million) total principal notes due December 11, 2014 at a fixed, annual interest rate of 5.375%.

   

£350 million (approximately $550 million) total principal notes due July 18, 2018 at a fixed, annual interest rate of 7.250%.

We expect to continue to comply with our long-term debt covenants.

At September 30, 2010 and December 31, 2009, our long-term debt consisted of (interest rates were as of September 30, 2010):

 

         September 30,
2010
    December 31,
2009
 
         (in millions)  
 

Notes, 2.625% to 7.55% (average effective rate 5.86%),
due through 2040

   $ 24,377      $ 14,395   
 

Euro notes, 5.75% to 6.25% (average effective rate 5.98%),
due through 2015

     3,879        4,072   
 

Sterling notes, 4.88% to 7.25% (average effective rate 4.59%),
due through 2018

     1,226          
 

Other foreign currency obligations

     165        5   
 

Capital leases and other

     57        65   
                  
 

Total

     29,704        18,537   
 

Less current portion of long-term debt

     (133     (513
                  
 

Long-term debt

   $     29,571      $     18,024   
                  

 

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

 

  

 

2011

   $ 133     
 

2012

     6,395     
 

2013

     1,760     
 

2014

     2,307     
 

2015

     2,035     
 

Thereafter

     17,071     

On August 11, 2010, we repaid $500 million of our long-term debt. This repayment was primarily financed from cash from operations.

Fair Value:

The aggregate fair value of our total debt, based on quoted prices in active markets for identical liabilities, at September 30, 2010, was $33,731 million as compared with the carrying value of $30,035 million. The aggregate fair value of our total debt, based on quoted prices in active markets for identical liabilities, at December 31, 2009, was $20,222 million as compared with the carrying value of $18,990 million.

 

13


 

Interest and Other Expense:

Interest and other expense was:

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
         2010      2009     2010     2009  
         (in millions)  
 

Interest and other expense, net:

         
 

Interest expense, debt

   $ 433       $ 322      $ 1,255      $ 936   
 

Acquisition-related financing fees

                    251          
 

Other (income) / expense, net

             1        (10     (21
                                   
 

Total interest and other expense, net

   $ 433       $             323      $ 1,496      $                915   
                                   

 

Acquisition-related financing fees include hedging and foreign currency impacts associated with the Cadbury acquisition and other fees associated with the Cadbury Bridge Facility.

 

Note 8.  Capital Stock:

 

Our articles of incorporation authorize 3.0 billion shares of Class A common stock, 2.0 billion shares of Class B common stock and 500 million shares of preferred stock. There were no Class B common shares or preferred shares issued and outstanding at September 30, 2010. Shares of Class A common stock issued, repurchased and outstanding were:

 

   

  

    

         Shares Issued      Shares
     Repurchased     
    Shares
Outstanding
       
 

Balance at January 1, 2010

     1,735,000,000         (257,115,097     1,477,884,903     
 

Shares issued

     261,537,778                261,537,778     
 

Exercise of stock options and
issuance of other stock awards

             6,337,532        6,337,532     
                             
 

Balance at September 30, 2010

     1,996,537,778         (250,777,565     1,745,760,213     
                             

In the first nine months of 2010, we issued 262 million additional shares of our Common Stock as part of the Cadbury acquisition. The issued stock had a total fair value of $7,457 million based on the average of the high and low market prices on the dates of issuance.

 

14


 

Note 9.  Accumulated Other Comprehensive Earnings / (Losses):

The components of accumulated other comprehensive earnings / (losses) were:

 

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

Balances at December 31, 2009

   $ (506   $ (3,550   $ 101      $ (3,955
 

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

        
 

Currency translation adjustments

     (691     24               (667
 

Amortization of experience
losses and prior service costs

                   –        148                         148   
 

Settlement losses

            69               69   
 

Net actuarial loss arising during
period

            (54            (54
 

Change in fair value of cash flow
hedges

                   (261     (261
                
 

Total other comprehensive losses

           (765
                                  
 

Balances at September 30, 2010

   $ (1,197   $ (3,363   $ (160   $ (4,720
                                  

Note 10.  Stock Plans:

Restricted and Deferred Stock:

In January 2010, we granted 1.7 million shares of stock in connection with our long-term incentive plan, and the market value per share was $27.33 on the date of grant. During the first nine months of 2010, we granted an additional 0.6 million shares of stock in connection with our long-term incentive plan and market value per share was $29.15 on the date of grant. In February 2010, as part of our annual equity program, we issued 2.5 million shares of restricted and deferred stock to eligible employees, and the market value per restricted or deferred share was $29.15 on the date of grant. During the first nine months of 2010, we issued an additional 0.9 million shares of restricted and deferred stock at a weighted-average market value per restricted or deferred share of $29.54, including shares issued to Cadbury employees in the second quarter of 2010 under our annual equity program. In aggregate, we issued 5.7 million restricted and deferred shares during the first nine months of 2010, including those issued as part of our long-term incentive plan.

During the first nine months of 2010, 3.9 million shares of restricted and deferred stock vested at a market value of $114 million.

Stock Options:

In February 2010, as part of our annual equity program, we granted 15.0 million stock options to eligible employees at an exercise price of $29.15. During the first nine months of 2010, we granted an additional 3.0 million stock options at a weighted-average exercise price of $29.71, including options granted to Cadbury employees in the second quarter of 2010 under our annual equity program. In aggregate, we granted 18.0 million stock options in the first nine months of 2010.

There were 5.2 million stock options exercised during the first nine months of 2010 with a total intrinsic value of $65 million.

 

15


 

Note 11.  Benefit Plans:

Pension Plans

Components of Net Periodic Pension Cost:

Net periodic pension cost consisted of the following for the three and nine months ended September 30, 2010 and 2009:

 

         U.S. Plans     Non-U.S. Plans  
         For the Three Months Ended     For the Three Months Ended  
         September 30,     September 30,  
         2010     2009     2010     2009  
         (in millions)  
 

Service cost

   $ 36      $ 36      $ 40      $ 15   
 

Interest cost

     92        92        98        54   
 

Expected return on plan assets

     (122     (122     (111     (60
 

Amortization:

        
 

Net loss from experience differences

     43        41        18        6   
 

Prior service cost

     1        2        2        1   
 

Other expenses

     30        15                 
                                  
 

Net periodic pension cost

   $            80      $            64      $            47      $            16   
                                  
         U.S. Plans     Non-U.S. Plans  
         For the Nine Months Ended     For the Nine Months Ended  
         September 30,     September 30,  
         2010     2009     2010     2009  
         (in millions)  
 

Service cost

   $ 108      $ 114      $ 117      $ 45   
 

Interest cost

     275        276        283        156   
 

Expected return on plan assets

     (367     (364     (318     (175
 

Amortization:

        
 

Net loss from experience differences

     128        120        54        17   
 

Prior service cost

     4        5        5        4   
 

Other expenses

     91        81                 
                                  
 

Net periodic pension cost

   $          239      $          232      $          141      $            47   
                                  

A significant portion of the 2010 increase in non-U.S. net periodic pension cost related to the Cadbury acquisition. The following costs are included within other expenses above. Severance payments related to our cost savings initiatives and lump-sum payments made to retired employees resulted in settlement losses under our U.S. plans of $30 million for the three months and $86 million for the nine months ended September 30, 2010, and $15 million for the three months and $81 million for the nine months ended September 30, 2009. Our U.S. plans also incurred a $5 million curtailment expense in the first quarter of 2010 related to the divestiture of our Frozen Pizza business.

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 nine months of 2010, we contributed $33 million to our U.S. plans and $180 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 $100 million to our non-U.S. plans during the remainder of 2010. 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.

 

16


 

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following for the three and nine months ended September 30, 2010 and 2009:

 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
         2010     2009     2010     2009  
         (in millions)  
 

Service cost

   $ 9      $ 7      $ 29      $ 26   
 

Interest cost

     42        43        128        130   
 

Amortization:

        
 

Net loss from experience differences

     14        11        41        33   
 

Prior service credit

     (7     (8     (23     (24
                                  
 

Net postretirement health care costs

   $     58      $ 53      $ 175      $ 165   
                                  

Postemployment Benefit Plans

 

Net postemployment costs consisted of the following for the three and nine months ended September 30, 2010 and 2009:

 

  

   

         For the Three Months Ended     For the Nine Months Ended  
         September 30,     September 30,  
         2010     2009     2010     2009  
         (in millions)  
 

Service cost

   $ 2      $ 2      $ 6      $ 6   
 

Interest cost

     3        3        7        6   
 

Amortization of net (gains) / losses

     (1     (1     (1     2   
 

Other credits, net

                          (7
                                  
 

Net postemployment costs

   $       4      $       4      $     12      $       7   
                                  

The following items are included in other credits above. We incurred severance charges of $25 million during the second quarter of 2009 related to our Kraft Foods Europe Reorganization. We also reversed $32 million of severance charges in the second quarter of 2009 related to our Restructuring Program as we sold a plant in Spain that we previously announced we would close under the program.

 

17


 

Note 12. Financial Instruments:

Fair Value of Derivative Instruments:

The fair values of derivative instruments recorded in the condensed consolidated balance sheet as of September 30, 2010 and December 31, 2009 were:

 

         September 30, 2010      December 31, 2009  
         Asset
     Derivatives     
    Liability
     Derivatives     
     Asset
    Derivatives    
    Liability
     Derivatives     
 
         (in millions)  
 

Derivatives designated as
hedging instruments:

         
 

Foreign exchange contracts

   $ 8      $ 200       $              8      $          158   
 

Commodity contracts

     52        7         25        14   
 

Interest rate contracts

     12        294         153          
                                   
     $ 72      $ 501       $          186      $          172   
                                   
 

Derivatives not designated
as hedging instruments:

         
 

Foreign exchange contracts

   $ 69      $ 69       $ 2      $              –   
 

Commodity contracts

     152        145         71        62   
 

Interest rate contracts

     72        33                  
                                   
     $ 293      $ 247       $            73      $            62   
                                   
 

Total fair value

   $           365      $          748       $          259      $          234   
                                   

The majority of the increase in derivatives not designated as hedging instruments was a result of the Cadbury acquisition as we did not re-designate them for hedge accounting. 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 September 30, 2010 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

   $           (192   $       $     (192   $               –   
 

Commodity contracts

     52        18         34          
 

Interest rate contracts

     (243             (243       
                                   
 

Total derivatives

   $          (383   $ 18       $       (401   $                 –   
                                   

Level 2 financial assets and liabilities consist of commodity forwards; foreign exchange forwards, currency swaps, and options; and interest rate swaps.

Commodity derivatives are valued using an income approach based on the observable market commodity index prices less the contract rate multiplied by the notional amount. Foreign currency contracts are valued using an income approach based on observable market forward rates less the contract rate multiplied by the notional amount. Our calculation of the fair value of interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the observable market interest rate curve. Our calculation of the fair value of financial instruments takes into consideration the risk of nonperformance, including counterparty credit risk.

 

18


 

Cash Flow Hedges:

Cash flow hedges affected accumulated other comprehensive earnings / (losses), net of income taxes, as follows:

 

         For the Three Months  Ended
September 30,
    For the Nine Months Ended
September 30,
 
         2010     2009     2010     2009  
         (in millions)  
 

Accumulated gain / (loss) at beginning
of period

   $ (66   $ 29      $ 101      $ (23
 

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

     (7     (2     (13     87   
 

Unrealized loss in fair value

     (87     (27     (248     (64
                                  
 

Accumulated loss at September 30

   $ (160   $      $ (160   $   
                                  
The effects of cash flow hedges for the three and nine months ended September 30, 2010 and 2009 were:   
         For the Three Months Ended
September 30, 2010
    For the Three Months Ended
September 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
 
         (in millions)  
 

Foreign exchange contracts –
intercompany loans

   $ 2      $      $ 4      $   
 

Foreign exchange contracts –
forecasted transactions

     (4            (13     (11
 

Commodity contracts

     32        (7     (11     9   
 

Interest rate contracts

     (117            (7       
                                  
 

Total

   $ (87   $ (7   $ (27   $ (2
                                  
         For the Nine Months Ended
September 30, 2010
    For the Nine Months Ended
September 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
 
         (in millions)  
 

Foreign exchange contracts –
intercompany loans

   $ 3      $      $ 5      $   
 

Foreign exchange contracts –
forecasted transactions

     21        (14     (36     (39
 

Commodity contracts

     29               (47     126   
 

Interest rate contracts

     (301     1        14          
                                  
 

Total

   $ (248   $ (13   $ (64   $ 87   
                                  

 

19


 

         For the Three Months  Ended
September 30, 2010
     For the Three Months  Ended
September 30, 2009
 
            Gain / (Loss) on   
Ineffectiveness
Recognized
in Earnings
    Gain / (Loss) on
Amount  Excluded
from Effectiveness
Testing Recognized
in  Earnings
        Gain / (Loss) on   
Ineffectiveness
Recognized
in Earnings
     Gain / (Loss) on
Amount  Excluded
from Effectiveness
Testing Recognized
in  Earnings
 
         (in millions)  
 

Foreign exchange contracts –
intercompany loans

   $      $       $       $   
 

Foreign exchange contracts –
forecasted transactions

                              
 

Commodity contracts

     3        3                 1   
 

Interest rate contracts

                              
                                    
 

Total

   $ 3      $ 3       $       $ 1   
                                    
         For the Nine Months Ended
September  30, 2010
     For the Nine Months Ended
September  30, 2009
 
         Gain / (Loss)  on
Ineffectiveness
Recognized
in Earnings
    Gain / (Loss) on
Amount  Excluded
from Effectiveness
Testing Recognized
in Earnings
     Gain / (Loss) on
Ineffectiveness
Recognized
in Earnings
     Gain / (Loss) on
Amount  Excluded
from Effectiveness
Testing Recognized
in Earnings
 
         (in millions)  
 

Foreign exchange contracts –
intercompany loans

   $      $       $       $   
 

Foreign exchange contracts –
forecasted transactions

                              
 

Commodity contracts

     (6     2         2         1   
 

Interest rate contracts

                              
                                    
 

Total

   $ (6   $ 2       $ 2       $ 1   
                                    

We record (i) the gain or loss reclassified from accumulated other comprehensive earnings / (losses) into earnings, (ii) the gain or loss on ineffectiveness, and (iii) the gain or loss on the amount excluded from effectiveness testing in:

 

   

cost of sales for commodity contracts;

   

cost of sales for foreign exchange contracts related to forecasted transactions; and

   

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

We expect to transfer unrealized gains of $30 million (net of taxes) for commodity cash flow hedges, unrealized gains of $15 million (net of taxes) for foreign currency cash flow hedges and unrealized losses of $1 million (net of taxes) for interest rate cash flow hedges to earnings during the next 12 months.

Hedge Coverage:

As of September 30, 2010, we had hedged forecasted transactions for the following durations:

 

   

commodity transactions for periods not exceeding the next 18 months;

   

interest rate transactions for periods not exceeding the next 32 years and 7 months; and

   

foreign currency transactions for periods not exceeding the next 15 months.

 

20


 

Fair Value Hedges:

The effects of fair value hedges for the three and nine months ended September 30, 2010 and 2009 were:

 

         For the Three Months Ended
September 30, 2010
    For the Three Months  Ended
September 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
     
         (in millions)      
 

Interest rate contracts

   $ 3      $ (3   $ 8      $ (8  
         For the Nine Months Ended
September 30, 2010
    For the Nine Months Ended
September 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
     
         (in millions)      
 

Interest rate contracts

   $ 6      $ (6   $ 7      $ (7  

 

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 effects of hedges of net investments in foreign operations for the three and nine months ended September 30, 2010 and 2009 were:

 

         Gain / (Loss) Recognized in OCI    

Location of

Gain / (Loss)
Recorded in

AOCI

         For the Three
Months Ended

September  30, 2010
    For the Three
Months Ended

September  30, 2009
    For the Nine
Months Ended

September  30, 2010
    For the Nine
Months Ended

September  30, 2009
   
         (in millions)      
 

Euro notes

   $ (253   $ (110   $ 125      $ (122  

Currency Translation

Adjustment

 

Economic Hedges:

The effects of economic hedges, derivatives that are not designated as hedging instruments, for the three and nine months ended September 30, 2010 and 2009 were:

 

         Gain / (Loss) Recognized in Earnings     Location of
         For the Three     For the Three     For the Nine     For the Nine     Gain / (Loss)
         Months Ended     Months Ended     Months Ended     Months Ended     Recognized
         September 30, 2010     September 30, 2009     September 30, 2010     September 30, 2009    

in Earnings

         (in millions)      
 

Foreign exchange contracts:

          
 

Intercompany loans and
forecasted interest
payments

   $ 35      $ (4   $ 58      $ (12   Interest expense
 

Forecasted transactions

     (3     (2     (1     (8   Cost of sales
 

Forecasted transactions

                   (17          Interest expense
 

Cadbury acquisition related

                   (395          Interest expense
 

Interest rate contracts

     (1            4             Interest expense
 

Commodity contracts

     29        (7     40        9      Cost of sales
                                    
 

Total

   $ 60      $ (13   $ (311   $ (11  
                                    

The hedging losses related to the Cadbury acquisition were economically offset by foreign exchange movement net gains of $240 million on the British pound cash, Cadbury Bridge Facility and payable balances associated with the acquisition. See our consolidated financial statements for the year ended December 31, 2009 for additional information on our purpose for entering into derivatives not designated as hedging instruments and our overall risk management strategies.

 

21


 

Volume:

As of September 30, 2010 and December 31, 2009, we had the following outstanding hedges:

 

         Notional Amount                       
         September 30,
2010
     December 31,
2009
                      
         (in millions)                       
 

Foreign exchange contracts:

              
 

Intercompany loans and forecasted
interest payments

   $ 3,365       $ 1,376            
 

Forecasted transactions

     1,351         631            
 

Commodity contracts

     368         1,832            
 

Interest rate contracts

     5,197         2,350            
 

Net investment hedge – euro notes

     3,885         4,081            

 

Note 13.  Commitments and Contingencies:

 

Legal Proceedings:

We routinely are involved in legal proceedings, claims and governmental inspections or investigations (“Legal Matters”) arising in the ordinary course of our business. Currently, we do not believe that the ultimate costs to resolve any of the Legal Matters will have a material effect on our financial results.

 

Third-Party Guarantees:

We have third-party guarantees primarily covering the long-term obligations of our vendors. As part of those transactions, we guarantee that third parties will make contractual payments or achieve performance measures. At September 30, 2010, the carrying amount of our third-party guarantees on our condensed consolidated balance sheet and the maximum potential payment under these guarantees was $29 million. Substantially all of these guarantees expire at various times through 2018.

 

Leases:

As of September 30, 2010, minimum rental commitments under non-cancelable operating leases in effect at quarter-end were (in millions):

 

  

  

    

  

      

  

   

 

2011

      $ 387            
 

2012

        359            
 

2013

        243            
 

2014

        159            
 

2015

        125            
 

Thereafter

        275            

Note 14.  Income Taxes:

As of January 1, 2010, our unrecognized tax benefits were $829 million. If we had recognized all of these benefits, the net impact on our income tax provision would have been $661 million. Our unrecognized tax benefits were $1,193 million at September 30, 2010, and if we had recognized all of these benefits, the net impact to our income tax provision would have been $863 million. The amount of unrecognized tax benefits could decrease by approximately $55 million during the next 12 months due to the potential resolution of certain foreign, U.S. federal and state examinations. Furthermore, we recorded $302 million of unrecognized tax benefits and $47 million of accrued interest and penalties as part of our purchase price allocations for Cadbury, which are subject to revision when the purchase price allocations are finalized in the fourth quarter of 2010. We include accrued interest and penalties related to uncertain tax positions in our tax provision. We had accrued interest and penalties of $210 million as of January 1, 2010 and $242 million as of September 30, 2010.

 

22


 

The changes in our unrecognized tax benefits for the nine months ended September 30, 2010 and 2009 were (in millions):

 

         2010     2009        
 

January 1

   $ 829      $ 807     
 

Increases from positions taken during prior periods

     8        29     
 

Decreases from positions taken during prior periods

     (80     (196  
 

Increases from positions taken during the current period

     186        107     
 

Increases from acquisition adjustments

     302            
 

Decreases relating to settlements with taxing authorities

     (15     (11  
 

Reductions resulting from the lapse of the applicable
statute of limitations

     (15     (14  
 

Currency / other

     (22     22     
                    
 

September 30

   $       1,193      $       744     
                    

 

The tax effects of temporary differences that gave rise to deferred income tax assets and liabilities consisted of the following at September 30, 2010 and December 31, 2009:

 

   

         September 30,
2010
    December 31,
2009
       
         (in millions)        
 

Deferred income tax assets:

      
 

Accrued postretirement and postemployment benefits

   $ 1,347      $ 1,472     
 

Accrued pension costs

     682        456     
 

Other

     2,655        1,997     
                    
 

Total deferred income tax assets

     4,684        3,925     
                    
 

Valuation allowance

     (356     (97  
                    
 

Net deferred income tax assets

   $ 4,328      $ 3,828     
                    
 

Deferred income tax liabilities:

      
 

Trade names

   $ (7,404   $ (4,431  
 

Property, plant and equipment

     (1,964     (2,029  
 

Other

     (701     (1,055  
                    
 

Total deferred income tax liabilities

     (10,069     (7,515  
                    
 

Net deferred income tax liabilities

   $ (5,741   $ (3,687  
                    

 

23


 

Note 15.  Earnings Per Share:

Basic and diluted EPS were calculated using the following:

 

         For the Three Months Ended
September 30,
     For the Nine Months Ended
September 30,
 
         2010      2009      2010      2009  
         (in millions, except per share data; 2009 revised)  
 

Earnings from continuing operations

   $ 760       $ 774       $ 1,948       $ 2,158   
 

Earnings and gain from discontinued
operations, net of income taxes

             52         1,644         159   
                                     
 

Net earnings

     760         826         3,592         2,317   
 

Noncontrolling interest

     6         2         18         6   
                                     
 

Net earnings attributable to Kraft Foods

   $ 754       $ 824       $ 3,574       $ 2,311   
                                     
 

Weighted-average shares for basic EPS

     1,748         1,479         1,702         1,477   
 

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

     6         8         6         8   
                                     
 

Weighted-average shares for diluted EPS

     1,754         1,487         1,708         1,485   
                                     
 

Basic earnings per share attributable
to Kraft Foods:

           
 

Continuing operations

   $ 0.43       $ 0.52       $ 1.13       $ 1.45   
 

Discontinued operations

             0.04         0.97         0.11   
                                     
 

Net earnings attributable to Kraft Foods

   $ 0.43       $ 0.56       $ 2.10       $ 1.56   
                                     
 

Diluted earnings per share attributable
to Kraft Foods:

           
 

Continuing operations

   $ 0.43       $ 0.52       $ 1.13       $ 1.45   
 

Discontinued operations

             0.03         0.96         0.11   
                                     
 

Net earnings attributable to Kraft Foods

   $       0.43       $       0.55       $       2.09       $       1.56   
                                     

We exclude antidilutive Kraft Foods stock options from our calculation of weighted-average shares for diluted EPS. We excluded 31.3 million antidilutive stock options for the three months and 27.8 million antidilutive stock options for the nine months ended September 30, 2010, and we excluded 23.2 million antidilutive stock options for the three months and 23.3 million antidilutive stock options for the nine months ended September 30, 2009.

Note 16.  Segment Reporting:

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

 

24


 

Management uses segment operating income to evaluate segment performance and allocate resources. We believe it is appropriate to disclose this measure to help investors analyze segment performance and trends. Segment operating income excludes unrealized gains and losses on hedging activities (which are a component of cost of sales), certain components of our U.S. pension plan cost (which is a component of cost of sales and selling, general and administrative expenses), general corporate expenses (which are a component of selling, general and administrative expenses) and amortization of intangibles for all periods presented. We exclude certain components of our U.S. pension plan cost from segment operating income because we centrally manage pension plan funding decisions and the determination of discount rate, expected rate of return on plan assets and other actuarial assumptions. Therefore, we allocate only the service cost component of our U.S. pension plan expense to segment operating income. 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, we record gains and losses on hedging activities 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
September 30,
     For the Nine Months Ended
September 30,
 
         2010      2009      2010      2009  
         (in millions; 2009 as revised)  
 

Net revenues:

           
 

Kraft Foods North America:

           
 

U.S. Beverages

   $ 756       $ 754       $ 2,463       $ 2,373   
 

U.S. Cheese

     863         824         2,505         2,605   
 

U.S. Convenient Meals

     806         774         2,415         2,335   
 

U.S. Grocery

     779         778         2,518         2,569   
 

U.S. Snacks

     1,505         1,232         4,413         3,717   
 

Canada & N.A. Foodservice

     1,164         1,010         3,408         2,868   
 

Kraft Foods Europe

     2,670         2,070         8,172         6,081   
 

Kraft Foods Developing Markets

     3,320         1,955         9,540         5,609   
                                     
 

Net revenues

   $     11,863       $       9,397       $     35,434       $     28,157   
                                     

 

25


 

         For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 
         2010     2009     2010     2009  
         (in millions; 2009 as revised)  
 

Earnings from continuing operations
before income taxes:

        
 

Operating income:

        
 

Kraft Foods North America:

        
 

U.S. Beverages

   $ 131      $ 133      $ 481      $ 443   
 

U.S. Cheese

     169        166        439        463   
 

U.S. Convenient Meals

     82        63        267        208   
 

U.S. Grocery

     244        258        887        859   
 

U.S. Snacks

     216        196        663        530   
 

Canada & N.A. Foodservice

     160        140        435        339   
 

Kraft Foods Europe

     332        211        956        565   
 

Kraft Foods Developing Markets

     370        285        1,158        745   
 

Unrealized gains on hedging activities

     16        19               140   
 

Certain U.S. pension plan costs

     (42     (27     (123     (121
 

General corporate expenses

     (106     (99     (591     (186
 

Amortization of intangibles

     (53     (6     (146     (15
                                  
 

Operating income

     1,519        1,339        4,426        3,970   
 

Interest and other expense, net

     433        323        1,496        915   
                                  
 

Earnings from continuing operations
before income taxes

   $         1,086      $         1,016      $         2,930      $         3,055   
                                  

Unrealized Gains / (Losses) on Hedging Activities – We recognized gains on the change in unrealized hedging positions of $16 million for the three months ended September 30, 2010, and gains of $19 million for the three months and $140 million for the nine months ended September 30, 2009.

General Corporate Expenses – The 2010 increase in general corporate expenses was primarily due to acquisition-related transaction fees, Integration Program costs and the impact of Cadbury’s corporate charges.

Restructuring Costs – We incurred charges under the Integration Program of $92 million for the three months and $284 million for the nine months ended September 30, 2010. We recorded these charges in operations, primarily as a part of selling, general and administrative expenses within our Kraft Foods Europe and Kraft Foods Developing Markets segments, as well as general corporate expenses. We also incurred charges associated with our cost savings initiatives of $17 million for the three months and $93 million for the nine months ended September 30, 2010. We recorded these charges in operations, primarily within selling, general and administrative expenses within our Kraft Foods Europe and Canada & N.A. Foodservice segments, as well as general corporate expenses.

 

26


 

Total assets by segment were:

 

         September 30,
2010
     December 31,
2009
               
         (in millions)                
 

Total assets:

           
 

Kraft Foods North America:

           
 

U.S. Beverages

   $ 2,325       $ 2,382         
 

U.S. Cheese

     4,549         4,589         
 

U.S. Convenient Meals

     2,023         3,063         
 

U.S. Grocery

     5,602         5,565         
 

U.S. Snacks

     20,653         16,418         
 

Canada & N.A. Foodservice

     7,023         5,051         
 

Kraft Foods Europe

     23,546         16,073         
 

Kraft Foods Developing Markets

     24,445         11,087         
 

Unallocated assets (1)

     3,454         2,486         
                         
 

Total assets

   $       93,620       $       66,714         
                         
 

 

(1)       Unallocated assets consist primarily of cash and cash equivalents, deferred income taxes, centrally held property, plant and equipment, prepaid pension assets and derivative financial instrument balances.

    

 

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, Kraft Foods Europe and Kraft Foods Developing Markets into sector components, were:

 

    

         For the Three Months Ended September 30, 2010  
         Kraft Foods
North America
     Kraft Foods
Europe
     Kraft Foods
Developing
Markets
     Total  
         (in millions)  
 

Biscuits (1)

   $ 1,394       $ 514       $ 681       $ 2,589   
 

Confectionery (1)

     481         1,203         1,674         3,358   
 

Beverages

     895         561         595         2,051   
 

Cheese

     1,226         233         209         1,668   
 

Grocery

     700         86         130         916   
 

Convenient Meals

     1,177         73         31         1,281   
                                     
 

Total net revenues

   $ 5,873       $       2,670       $         3,320       $       11,863   
                                     
         For the Three Months Ended September 30, 2009  
         Kraft Foods
North America
     Kraft Foods
Europe
     Kraft Foods
Developing
Markets
     Total  
         (in millions; as revised)  
 

Biscuits (1)

   $ 1,416       $ 573       $ 621       $ 2,610   
 

Confectionery (1)

     70         504         430         1,004   
 

Beverages

     881         572         518         1,971   
 

Cheese

     1,174         244         216         1,634   
 

Grocery

     706         96         140         942   
 

Convenient Meals

     1,125         81         30         1,236   
                                     
 

Total net revenues

   $ 5,372       $ 2,070       $ 1,955       $ 9,397   
                                     

 

27


 

         For the Nine Months Ended September 30, 2010  
         Kraft Foods
North America
     Kraft Foods
Europe
     Kraft Foods
Developing
Markets
         Total      
         (in millions)  
 

Biscuits (1)

   $ 4,157       $ 1,730       $ 1,956       $ 7,843   
 

Confectionery (1)

     1,258         3,541         4,623         9,422   
 

Beverages

     2,857         1,730         1,834         6,421   
 

Cheese

     3,618         715         634         4,967   
 

Grocery

     2,363         254         401         3,018   
 

Convenient Meals

     3,469         202         92         3,763   
                                     
 

Total net revenues

   $     17,722       $         8,172       $         9,540       $       35,434   
                                     
         For the Nine Months Ended September 30, 2009  
         Kraft Foods
North America
     Kraft Foods
Europe
     Kraft Foods
Developing
Markets
     Total  
         (in millions; as revised)  
 

Biscuits (1)

   $ 4,196       $ 1,689       $ 1,754       $ 7,639   
 

Confectionery (1)

     183         1,524         1,289         2,996   
 

Beverages

     2,727         1,676         1,476         5,879   
 

Cheese

     3,593         706         604         4,903   
 

Grocery

     2,408         271         400         3,079   
 

Convenient Meals

     3,360         215         86         3,661   
                                     
 

Total net revenues

   $ 16,467       $ 6,081       $ 5,609       $ 28,157   
                                     
 

(1)       Biscuits and Confectionery were previously reported combined as Snacks. With the Cadbury acquisition, the Biscuits and Confectionery sectors have been broken out separately. The Biscuits sector primarily includes Cookies, Crackers and Nuts. The Confectionery sector primarily includes Chocolate, Gum and Candy.

     

Note 17.  Subsequent Events:

We evaluated subsequent events and included all accounting and disclosure requirements related to subsequent events in our financial statements.

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 80 countries and sell our products in approximately 170 countries.

Executive Summary

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

 

   

Net revenues increased 26.2% to $11.9 billion in the third quarter of 2010 and increased 25.8% to $35.4 billion in the first nine months of 2010 as compared to the same periods in the prior year.

 

   

Diluted EPS attributable to Kraft Foods decreased 21.8% to $0.43 in the third quarter of 2010 and increased 34.0% to $2.09 in the first nine months of 2010 as compared to the same periods in the prior year.

 

28


 

   

Diluted EPS attributable to Kraft Foods from continuing operations decreased 17.3% to 0.43 in the third quarter of 2010 and decreased 22.1% to $1.13 in the first nine months of 2010 as compared to the same periods in the prior year.

 

   

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

 

   

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

 

   

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

Discussion and Analysis

Items Affecting Comparability of Financial Results

Acquisitions and Divestitures

Cadbury Acquisition:

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

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

As part of our Cadbury acquisition, we expensed and incurred transaction related fees of $2 million for the three months, $217 million for the nine months ended September 30, 2010 and $11 million for the three and nine months ended September 30, 2009. We recorded these expenses within selling, general and administrative expenses. We also incurred acquisition financing fees of $96 million in the first quarter of 2010. We recorded these expenses within interest and other expense, net.

Cadbury contributed net revenues of $6,376 million and net earnings of $369 million from February 2, 2010 through September 30, 2010. The following unaudited pro forma summary presents Kraft Foods’ consolidated information as if Cadbury had been acquired on January 1, 2009. These amounts were calculated after conversion to accounting principles generally accepted in the United States of America (“U.S. GAAP”), applying our accounting policies, and adjusting Cadbury’s results to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant and equipment, and intangible assets had been applied from January 1, 2009, together with the consequential tax effects. These adjustments also reflect the additional interest expense incurred on the debt to finance the purchase, and the divestitures of certain Cadbury confectionery operations in Poland and Romania, as required by the EU Commission as a condition of our Cadbury acquisition.

 

29


 

         Pro forma for the
Three  Months
Ended September 30,
    Pro forma for the Nine
Months  Ended September 30,
 
         2009     2010      2009  
         (in millions)  
 

Net revenues

   $ 11,812      $               35,997       $               34,599   
 

Net earnings attributable to Kraft Foods

     725        3,420         2,097   

 

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

 

Our February 2, 2010 Cadbury acquisition was valued at $18,547 million, or $17,500 million net of cash and cash equivalents. As part of that acquisition, we acquired the following assets and assumed the following liabilities (in millions):

 

     

   

 

Receivables (1)

   $ 1,331        
 

Inventories

     1,298        
 

Other current assets

     695        
 

Property, plant and equipment

     3,312        
 

Goodwill (2)

     9,174        
 

Intangible assets (3)

     12,769        
 

Other assets

     376        
 

Short-term borrowings

     (1,206     
 

Accounts payable

     (1,689     
 

Other current liabilities (4)

     (1,711     
 

Long-term debt

     (2,436     
 

Deferred income taxes

     (2,583     
 

Accrued pension costs

     (816     
 

Other liabilities

     (981     
 

Noncontrolling interest

     (33     

 

  (1)    

The gross amount due under the receivables we acquired is $1,402 million, of which $71 million is expected to be uncollectable.

  (2)  

Goodwill will not be deductible for statutory tax purposes and is attributable to Cadbury’s workforce and the significant synergies we expect from the acquisition.

  (3)  

$10.2 billion of the intangible assets acquired are expected to be indefinite lived.

  (4)  

Within other current liabilities, a reserve for exposures related to taxes of approximately $70 million was established within our Developing Markets segment. The cumulative exposure was approximately $140 million at September 30, 2010.

The above amounts represent the allocation of purchase price and are substantially complete. We expect to finalize the purchase price allocation during the fourth quarter of 2010.

Pizza Divestiture:

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

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

 

30


 

Summary results of operations for the Frozen Pizza business through September 30, 2010 were:

 

         For the Three
Months Ended
    For the Nine Months Ended      
         September 30,
2009
    September 30,
2010
    September 30,
2009
     
         (in millions)      
 

Net revenues

   $ 406      $ 335      $ 1,204     
                            
 

 

Earnings before income taxes

     80        73        248     
 

Provision for income taxes

     (28     (25     (89  
 

Gain on discontinued operations, net of
income taxes

            1,596            
                            
 

Earnings and gain from discontinued
operations, net of income taxes

   $       52      $       1,644      $       159     
                            

 

Earnings before income taxes, as presented, exclude associated allocated overheads of $25 million for the nine months ended September 30, 2010, $28 million for the three months ended September 30, 2009 and $81 million for the nine months ended September 30, 2009.

 

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

 

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

 

 

Inventories, net

   $ 102         
 

Property, plant and equipment, net

     317         
 

Goodwill

     475         
                
 

Distributed assets of the Frozen
Pizza business

   $           894         
                

Other Divestitures:

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

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.

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

Restructuring Costs

Integration Program:

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

Integration Program costs include the costs associated with combining our operations with Cadbury’s and are separate from the costs related to the acquisition. We incurred charges under the Integration Program of $92 million for the three months and $284 million for the nine months ended September 30, 2010. We recorded these charges in operations, primarily as a part of selling, general and administrative expenses within our Kraft Foods Europe and Kraft Foods Developing Markets segments, as well as general corporate expenses. At September 30, 2010, we had an accrual of $229 million related to the Integration Program.

 

31


 

During the second quarter of 2010, we evaluated Cadbury’s Vision into Action (“VIA”) restructuring program and began managing it within our overall Integration Program. Cadbury initiated the VIA restructuring program in 2007 and planned to run it through 2011. Accordingly, we acquired an accrual of $248 million relating to charges taken in previous periods. In evaluating their program as part of our corporate strategies and our integration plans, we included the remaining charges within our overall Integration Program. As we move forward on a combined company basis, we do not intend to manage these programs separately.

Cost Savings Initiatives:

Cost savings initiatives generally include exit, disposal and other project savings costs. We incurred charges associated with our cost savings initiatives of $17 million for the three months and $93 million for the nine months ended September 30, 2010. We recorded these charges in operations, primarily within selling, general and administrative expenses within our Kraft Foods Europe and Canada & N.A. Foodservice segments, as well as general corporate expenses. These charges primarily included other project savings costs associated with the Kraft Foods Europe Reorganization. Even though other project savings costs were directly attributable to exit and disposal costs, they did not qualify for special accounting treatment as exit or disposal activities.

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 the elimination of approximately 18,600 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 third quarter of 2010, we reversed $9 million in Restructuring Program charges relating to severance benefits and other charges. In the second quarter of 2009, we sold a plant in Spain that we previously announced we would close under our Restructuring Program. Accordingly, we reversed $35 million in Restructuring Program charges 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 $1.7 billion of the $2.0 billion in expected cash payments, including $60 million paid in the first nine months of 2010. At September 30, 2010, we had accrued $177 million related to the Restructuring Program.

Provision for Income Taxes

Our effective tax rate was 30.0% in the third quarter of 2010 and 33.5% in the first nine months of 2010. Our third quarter 2010 effective tax rate included net tax benefits of $68 million, primarily resulting from several items in our international operations. For the first nine months of 2010, our effective tax rate included net tax benefits of $100 million. These net benefits were primarily due to the second quarter resolution of a federal tax audit, the tax impacts of the highly inflationary accounting adjustments related to our Venezuelan subsidiaries, and the resolution of several items in our international operations, partially offset by a $137 million write-off of deferred tax assets as a result of the U.S. health care legislation enacted in March 2010.

Our effective tax rate was 23.8% in the third quarter of 2009 and 29.4% in the first nine months of 2009. Our third quarter 2009 effective tax rate included net tax benefits of $143 million, primarily due to an agreement we reached with the IRS on specific matters, settlements with various foreign and state tax authorities, and the expiration of the statute of limitations in various jurisdictions. For the first nine months of 2009, our effective tax rate included net tax benefits of $205 million primarily due to an agreement we reached with the IRS on specific matters, settlements with various foreign and state tax authorities, and the expiration of the statute of limitations in various jurisdictions.

 

32


 

Consolidated Results of Operations

The following discussion compares our consolidated results of operations for the three months ended September 30, 2010 and 2009 and for the nine months ended September 30, 2010 and 2009.

Three Months Ended September 30:

         For the Three Months  Ended
September 30,
             
             2010             2009            $ change           % change     
         (in millions, except per
share data; 2009 revised)
             
 

Net revenues

   $  11,863         $    9,397         $    2,466              26.2%   
 

Operating income

     1,519        1,339        180        13.4%   
 

Earnings from continuing operations

     760        774        (14     (1.8%
 

Net earnings attributable to Kraft Foods

     754        824        (70     (8.5%
 

Diluted earnings per share attributable to
Kraft Foods from continuing operations

     0.43        0.52        (0.09     (17.3%
 

Diluted earnings per share attributable
to Kraft Foods

     0.43        0.55        (0.12     (21.8%

Net Revenues – Net revenues increased $2,466 million (26.2%) to $11,863 million in the third quarter of 2010, and organic net revenues increased $239 million (2.5%) to $9,624 million as follows.

 

   

 

Change in net revenues (by percentage point)

        
 

Favorable volume/mix

       0.2 pp     
 

Higher net pricing

       2.3 pp     
                
 

Total change in organic net revenues (1)

       2.5    
 

Impact from the Cadbury acquisition

       26.2 pp     
 

Unfavorable foreign currency

       (2.3 )pp     
 

Impact of divestitures

       (0.2 )pp     
                
 

Total change in net revenues

       26.2    
                
 

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

  

Unfavorable foreign currency decreased net revenues by $214 million, due primarily to the strength of the U.S. dollar against the euro and Venezuelan bolivar, partially offset by the strength of the Canadian dollar and Brazilian real versus the U.S. dollar. The Cadbury acquisition added $2,453 million in net revenues. The balance of the increase in net revenues was driven primarily by higher net pricing, mainly in Kraft Foods North America and Kraft Foods Developing Markets, and favorable volume/mix. The favorable volume/mix impact on revenues was driven primarily by higher base volume in Kraft Foods Developing Markets. In addition, the impact of prior year divestitures had an unfavorable impact on revenues.

 

33


 

Operating Income – Operating income increased $180 million (13.4%) to $1,519 million in the third quarter of 2010, due to the following:

 

         Operating
Income
     Change  
         (in millions)      (percentage point)  
 

Operating Income for the Three Months Ended
September 30, 2009 (as revised)

   $             1,339      
 

Change in operating income

     
 

Higher net pricing

     213         15.5pp   
 

Favorable volume/mix

     16         1.1pp   
 

Higher input costs

     (186)         (13.5)pp   
 

Increased operating income from the Cadbury acquisition

     290         21.5pp   
 

Lower acquisition-related costs associated with Cadbury

     9         0.8pp   
 

Integration Program costs

     (92)         (6.9)pp   
 

Higher selling, general and administrative expenses

     (40)         (2.9)pp   
 

Change in unrealized gains on hedging activities

     (3)         (0.2)pp   
 

Reversal of asset impairment and exit costs

     9         0.7pp   
 

Unfavorable foreign currency

     (38)         (2.9)pp   
 

Other, net

     2         0.2pp   
                   
 

Total change in operating income

     180         13.4%   
                   
 

Operating Income for the Three Months Ended
September 30, 2010

   $ 1,519      
             

Our input costs increased during the quarter, due to higher raw material costs, partially offset by lower manufacturing costs. The favorable volume/mix was primarily driven by strong contributions from Kraft Foods Developing Markets, partially offset by declines in U.S. Grocery and Canada & N.A. Foodservice. The Cadbury acquisition, net of Integration Program and acquisition-related costs, increased operating income by $207 million. Total selling, general and administrative expenses, as recorded in the condensed consolidated statement of earnings, increased $725 million from the third quarter of 2009, but excluding the impacts of divestitures, foreign currency and our Cadbury acquisition (including Integration Program and acquisition-related costs), increased $40 million over the third quarter of 2009. We recognized gains of $16 million on the change in unrealized hedging positions in the third quarter of 2010, versus gains of $19 million in the third quarter of 2009. During the third quarter of 2010, we reversed $9 million in Restructuring Program charges recorded in prior years. In addition, unfavorable foreign currency decreased operating income by $38 million, due primarily to the strength of the U.S. dollar against the euro and Venezuelan bolivar, which more than offset the strength of the Canadian dollar and Brazilian real against the U.S. dollar.

 

34


 

Net Earnings and Diluted Earnings per Share Attributable to Kraft Foods – Net earnings attributable to Kraft Foods of $754 million decreased by $70 million (8.5%) in the third quarter of 2010. Diluted EPS attributable to Kraft Foods from continuing operations was $0.43 in the third quarter of 2010, down $0.09 from $0.52 in the third quarter of 2009. Diluted EPS attributable to Kraft Foods was $0.43 in the third quarter of 2010, down $0.12 from $0.55 in the third quarter of 2009. These changes were due to the following:

 

                 Diluted EPS       
 

Diluted EPS Attributable to Kraft Foods for the Three
Months Ended September 30, 2009 (as revised)

      $ 0.55     
 

Discontinued operations

        0.03     
               
 

Diluted EPS Attributable to Kraft Foods from continuing
operations for the Three Months  Ended September 30,
2009 (as revised)

        0.52     
 

Acquisition-related costs

        0.01     
               
 

Operating EPS(1) for the Three Months Ended September 30, 2009

        0.53     
 

Increases in operations

        0.01     
 

Increases in operations from the Cadbury acquisition

        0.12     
 

Change in unrealized gains on hedging activities

            
 

Unfavorable foreign currency

        (0.02  
 

Higher interest and other expense, net (2)

        (0.05  
 

Changes in taxes (3)

        (0.06  
 

Higher shares outstanding

        (0.06  
               
 

Operating EPS(3) for the Three Months Ended September 30, 2010

        0.47     
 

Acquisition-related costs

        0.01     
 

Integration Program costs

        (0.05  
               

        

 

Diluted EPS Attributable to Kraft Foods for the Three
Months Ended September 30, 2010

      $ 0.43     
               
 

 

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

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

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

Nine Months Ended September 30:

                 
         For the Nine Months Ended
September  30,
              
                    
       2010      2009      $ change     % change  
         (in millions, except per
share data; 2009 revised)
              
 

Net revenues

   $     35,434       $     28,157       $       7,277              25.8%   
 

Operating income

     4,426         3,970         456        11.5%   
 

Earnings from continuing operations

     1,948         2,158         (210     (9.7%
 

Net earnings attributable to Kraft Foods

     3,574         2,311         1,263        54.7%   
 

Diluted earnings per share attributable to
Kraft Foods from continuing operations

     1.13         1.45         (0.32     (22.1%
 

Diluted earnings per share attributable
to Kraft Foods

     2.09         1.56         0.53        34.0%   

Net Revenues – Net revenues increased $7,277 million (25.8%) to $35,434 million in the first nine months of 2010, and organic net revenues increased $727 million (2.6%) to $28,817 million as follows. Please see the Non-GAAP Financial Measures section at the end of this item.

 

35


 

 

Change in net revenues (by percentage point)

        
 

Favorable volume/mix

     1.9pp         
 

Higher net pricing

     0.7pp         
                
 

Total change in organic net revenues

     2.6%         
 

Impact from the Cadbury acquisition

     22.7pp         
 

Favorable foreign currency

     0.8pp         
 

Impact of divestitures

     (0.3)pp         
                
 

Total change in net revenues

     25.8%         
                

Favorable foreign currency increased net revenues by $241 million, due primarily to the strength of the Canadian dollar, Brazilian real, Australian dollar, and Russian ruble against the U.S. dollar, partially offset by the strength of the U.S. dollar against the Venezuelan bolivar and euro. The Cadbury acquisition added $6,376 million in net revenues. The balance of the increase in net revenues was driven by favorable volume/mix and higher net pricing. The favorable volume/mix impact on revenues was driven primarily by higher base volume in Kraft Foods Developing Markets and Kraft Foods Europe. In addition, we had higher net pricing across all reportable segments, except Kraft Foods Europe and U.S. Snacks. The impact of prior year divestitures had an unfavorable impact on revenues.

 

Operating Income – Operating income increased $456 million (11.5%) to $4,426 million in the first nine months of 2010, due to the following:

 

         Operating
Income
    

Change

    
         (in millions)      (percentage point)     
 

Operating Income for the Nine Months Ended
September 30, 2009 (as revised)

   $ 3,970         
 

Change in operating income

        
 

Lower input costs

     1       0.2pp   
 

Favorable volume/mix

     306       7.5pp   
 

Higher net pricing

     210       5.1pp   
 

Increased operating income from the Cadbury acquisition

     762       19.1pp   
 

Higher acquisition-related costs associated with Cadbury

     (261)       (6.5)pp   
 

Integration Program costs

     (284)       (7.1)pp   
 

Higher selling, general and administrative expenses

     (159)       (3.9)pp   
 

Lower net reversals of asset impairment and exit costs

     (17)       (0.5)pp   
 

Change in unrealized gains on hedging activities

     (140)       (3.4)pp   
 

Lower losses on divestitures

     17       0.5pp   
 

Favorable foreign currency

     30       0.8pp   
 

Other, net

     (9)       (0.3)pp   
                  
 

Total change in operating income

     456       11.5%   
                  
 

Operating Income for the Nine Months Ended
September 30, 2010

   $       4,426         
                

Our input costs were essentially flat during the first nine months of 2010, as lower manufacturing costs were offset by higher raw material costs. The favorable volume/mix was primarily driven by strong contributions from Kraft Foods Developing Markets, Kraft Foods Europe, U.S. Beverages and U.S. Convenient Meals, partially offset by declines in U.S. Grocery, U.S. Cheese and U.S. Snacks. The Cadbury acquisition, net of Integration Program and higher acquisition-related costs, increased operating income by $217 million. Total selling, general and administrative expenses, as recorded in the condensed consolidated statement of earnings, increased $2,527 million from the first nine months of 2009, but excluding the impacts of divestitures, foreign currency and our Cadbury acquisition (including Integration Program and acquisition-related costs), increased $159 million over the first nine months of 2009, primarily due to further investments in our brands. We recognized no net gain or loss on the change in unrealized hedging positions in the first nine months of 2010, versus gains of $140 million in the first nine months of 2009. During the first nine months of 2010, we reversed $9 million in Restructuring Program charges recorded in prior years, versus a reversal of $35 million in Restructuring Program charges recorded in the first nine months of 2009. We recorded an asset impairment charge of $9 million to write off an investment in Norway in the first nine months of 2009. In addition, favorable foreign currency increased operating income by $30 million, due primarily to the strength of the Canadian dollar, Brazilian real, Korean won and Australian dollar against the U.S. dollar, partially offset by the strength of the U.S. dollar against the Venezuelan bolivar and euro.

 

36


 

Net Earnings and Diluted Earnings per Share Attributable to Kraft Foods – Net earnings attributable to Kraft Foods of $3,574 million increased by $1,263 million (54.7%) in the first nine months of 2010. Diluted EPS attributable to Kraft Foods from continuing operations was $1.13 in the first nine months of 2010, down 22.1% from $1.45 in the first nine months of 2009. Diluted EPS attributable to Kraft Foods was $2.09 in the first nine months of 2010, up $0.53 from $1.56 in the first nine months of 2009. These changes were due to the following:

 

         Diluted EPS        
 

Diluted EPS Attributable to Kraft Foods for the Nine
Months Ended September 30, 2009 (as revised)

   $ 1.56     
 

Discontinued operations

     0.11     
            
 

Diluted EPS Attributable to Kraft Foods from Continuing
Operations for the Nine Months Ended
September 30, 2009 (as revised)

     1.45     
 

Acquisition-related costs

     0.01     
            
 

Operating EPS(1) for the Nine Months Ended
September 30, 2009

     1.46     
            
 

Increases in operations

     0.17     
 

Increases in operations from the Cadbury acquisition

     0.30     
 

Change in unrealized gains on hedging activities

     (0.06  
 

Favorable foreign currency

     0.01     
 

Higher interest and other expense, net (2)

     (0.14  
 

Changes in taxes (3)

         
 

Higher shares outstanding

     (0.18  
            
 

Operating EPS(1) for the Nine Months Ended
September 30, 2010

     1.56     
            
 

Acquisition-related costs

     (0.12  
 

Acquisition-related interest and other expense, net

     (0.10  
 

Integration Program costs

     (0.13  
 

U.S. health care legislation impact on deferred taxes

     (0.08