Business context and reporting period
This is Kraft Foods Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2012. Although the request identifies Mondelez International, Inc., the filing registrant was Kraft Foods Inc.; it planned to retain the global snacks business and change its name to Mondelez International after spinning off the North American grocery business.
The proposed spin-off was targeted for October 1, 2012, subject to regulatory, tax, registration, contractual and board-approval conditions. The filing discusses the company’s packaged food businesses across North America, Europe and developing markets.
Financial results and key metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net revenues | $13.286 billion | $13.878 billion | $26.379 billion | $26.451 billion |
| Operating income | $1.879 billion | $1.806 billion | $3.570 billion | $3.452 billion |
| Net earnings attributable to Kraft Foods | $1.029 billion | $976 million | $1.842 billion | $1.775 billion |
| Diluted EPS | $0.58 | $0.55 | $1.03 | $1.01 |
| Operating EPS, non-GAAP | $0.68 | $0.62 | $1.25 | $1.14 |
- Reported revenue fell 4.3% in Q2 and 0.3% in the first half. Organic net revenue, a company-defined non-GAAP measure, rose 3.4% and 4.9%, respectively.
- Operating margins were 14.1% in Q2 versus 13.0% a year earlier, and 13.5% for the first half versus 13.1%.
- Six-month operating cash flow was $1.208 billion, compared with $296 million in 2011. Capital expenditures were $740 million; investing cash outflow was $644 million.
- Cash and cash equivalents were $4.643 billion at June 30, 2012, up from $1.974 billion at year-end 2011. Total debt was approximately $30.2 billion, up from $26.9 billion; the debt-to-capitalization ratio increased to 0.46 from 0.43.
- Current assets were $19.831 billion and current liabilities $16.054 billion at June 30. Dividends declared were $0.29 per share in Q2 and $0.58 per share for the first half.
Material changes versus the prior comparable period
- Pricing supported organic revenue growth: higher net pricing contributed 4.0 percentage points in Q2 and 4.7 points in the first half. Volume/mix detracted 0.6 points in Q2 but added 0.2 points for the first half.
- Foreign exchange reduced reported revenue by $685 million in Q2 and $884 million in the first half. The comparison was also affected by prior-year accounting calendar changes, which had boosted Q2 2011 revenue by about $360 million, and by the prior-year cessation of the Starbucks packaged coffee business.
- Operating income rose despite reported revenue declines, helped by pricing, lower integration costs and more favorable unrealized hedge results; higher input costs, currency effects and new spin-off and restructuring costs partly offset these benefits.
- Q2 net earnings attributable to Kraft Foods increased 5.4%, while first-half earnings increased 3.8%. Non-GAAP Operating EPS grew faster than GAAP diluted EPS, reflecting the exclusion of specified costs.
- Operating cash flow improved substantially year over year, primarily due to lower pension contributions and higher earnings, partly offset by working-capital uses.
Outlook, management commentary, risks and unusual items
- Management maintained its 2012 outlook for approximately 5% organic net revenue growth and at least 9% Operating EPS growth on a constant-currency basis. It cited business momentum amid weak consumer and category growth and input-cost inflation.
- Management expected commodity-price volatility and elevated costs to continue through the rest of 2012, with pricing, manufacturing-cost reductions and overhead controls as mitigation measures.
- The company approved a 2012–2014 restructuring program with $1.1 billion of restructuring and implementation costs; it expected about $950 million of restructuring charges, including approximately $560 million of cash expenditures, and completion by the end of 2014. It also approved $0.4 billion in related capital expenditures.
- Spin-off costs were part of a broader $1.7 billion one-time cost plan, with an additional estimated $400 million to $800 million of financing and related costs. The company recorded $128 million of spin-off costs in Q2 and $301 million for the first half, including interest expense.
- The Cadbury integration program was expected to generate about $800 million in annual cost savings by the end of 2013, with approximately $1.5 billion of total integration charges expected through 2013. About $1.3 billion had been incurred by June 30.
- In June, Kraft Foods Group issued $6.0 billion of notes at a weighted-average effective rate of 3.938%; proceeds were used in part to repay commercial paper. A July 18 debt exchange transferred $3.6 billion of debt to Kraft Foods Group without generating cash and will be reflected in the next quarter. Spin-off completion and the resulting standalone capital structures remained uncertain.
- Risks include spin-off delay or failure, execution and separation disruption, commodity inflation, pricing and competitive pressures, weak economic conditions, foreign-exchange exposure, indebtedness and global tax or regulatory matters. The filing also notes an ongoing SEC FCPA investigation concerning a Cadbury facility in India and an active Starbucks arbitration, in which Starbucks counterclaimed for damages. Management did not expect legal matters, individually or collectively, to have a material adverse effect, but outcomes were uncertain.
- Other unusual items included a $55 million pretax gain on a Russian property sale and a $20 million impairment charge for a Japanese trademark during the first half.
Most important facts for investors to verify
- Whether the spin-off closed on the announced terms and timeline, and the final debt, financing costs and liquidity allocated to each company.
- Whether organic growth and Operating EPS targets were achieved; review the non-GAAP definitions and reconciliations alongside reported results.
- How pricing, volumes, foreign exchange and input costs affected subsequent revenue, margins and cash generation.
- Actual restructuring, spin-off and Cadbury integration costs versus estimates, including cash requirements and savings delivered.
- Debt maturities, refinancing needs, credit-facility availability and the effect of debt transfers on standalone leverage.
- Developments in the SEC investigation, Starbucks arbitration and other contingencies, along with any resulting financial exposure.