Mondelez International, Inc. quarterly report, Q1 FY2010

Business context and reporting period

Kraft Foods Inc. (the registrant in this filing; now associated with Mondelez International) filed this unaudited Form 10-Q for the three months ended March 31, 2010. Kraft manufactures and markets packaged food products globally. Comparisons are with the three months ended March 31, 2009; 2009 results were revised to present the North American frozen pizza business as discontinued operations.

Key financial metrics

Amounts are in millions of dollars, except per-share data and ratios.

Reported revenue rose 26.0%, but organic revenue (excluding acquisitions, divestitures and currency) increased 3.3% to $9,242. Cadbury contributed $1,693 of revenue from February 2 through March 31. Reported net earnings included a $1,596 after-tax gain on the frozen pizza sale; therefore, total EPS growth does not represent continuing-business performance.

At March 31, cash and cash equivalents were $3,878, compared with $2,101 at year-end 2009. Current assets were $17,215 and current liabilities $15,581. Total debt was approximately $31.0 billion, versus $19.0 billion at December 31, 2009; the debt-to-capitalization ratio increased to 0.48 from 0.42. Total liabilities were $61,215 and total equity $34,494.

Material changes versus the prior comparable period

• Cadbury was acquired in February. The transaction added substantial revenue and assets, and Kraft issued 256 million shares; purchase price allocations remained preliminary.
• Revenue growth reflected Cadbury, favorable currency ($383 million), and 3.3% organic growth. Organic growth was mainly volume/mix, with a smaller contribution from pricing.
• Operating income increased only 2.6% despite lower input costs and improved volume/mix. Cadbury transaction and integration costs, higher marketing and administrative expense, and a less favorable change in unrealized hedge results offset much of the benefit.
• Continuing-operations earnings fell 58.7%, with interest and other expense rising to $624 million from $280 million. This included $247 million of acquisition-related financing fees; Kraft separately reported $203 million of Cadbury transaction fees in marketing, administration and research costs.
• Operating cash flow fell from $423 million provided to $5 million used, with management citing higher working-capital needs, including receivables timing and acquisition-related items.
• Kraft sold its North American frozen pizza business to Nestlé on March 1 for $3.7 billion. The reported after-tax gain was $1.596 billion, including $1.2 billion of tax expense. The business generated $335 million of revenue through the sale date, versus $417 million in the prior-year quarter.

Outlook, commentary, risks and unusual items

• For 2010, management expected diluted EPS of at least $2.35, including Operating EPS of at least $2.00, estimated integration costs of $0.30, acquisition-related costs and financing fees of $0.22, a $0.08 health-care-legislation charge, and $0.95 from the frozen pizza sale. These are management’s stated outlook measures, not reported results.
• For 2011, management targeted at least 5% organic revenue growth and mid-teens growth in Operating EPS. It cited strong base-business growth, Cadbury’s contribution, and some cost synergies, tempered near term by increased brand support, interest expense and share count.
• Management expected at least $675 million in annual cost savings by the end of the third year after the Cadbury acquisition, alongside approximately $1.3 billion of integration charges over the first three years. It reported $43 million of integration charges in Q1.
• Management expected full-year capital expenditures of approximately $1.7 billion and approximately $240 million of further pension contributions in 2010, primarily funded from operations. Commodity prices were expected to remain volatile.
• Venezuelan highly inflationary accounting and currency devaluation produced a $34 million Q1 charge; management expected a $100 million negative effect on 2010 operating results.
• Credit ratings were downgraded during the quarter following the increase in debt for Cadbury. Kraft reported compliance with debt covenants and expected to remain compliant. The $4.5 billion revolving facility was undrawn; its minimum-equity covenant was $28.5 billion, versus $38.6 billion of covenant-defined equity at quarter-end.
• Risks include successful Cadbury integration, leverage and debt service, commodity-cost volatility, competition and pricing, foreign-exchange exposure, regulatory matters, and tax uncertainties. The filing describes EU competition investigations involving FMCG companies, including Kraft, and says outcomes could not be predicted. The EU also required divestiture of Cadbury confectionery operations in Poland and Romania.
• Unrecognized tax benefits were $1.217 billion at quarter-end; total income-tax liabilities, including uncertain positions and related interest and penalties, were $2.9 billion, of which approximately $1.5 billion was expected to be paid within 12 months.
• Management concluded disclosure controls were effective. The internal-control assessment excluded Cadbury, which represented approximately 31% of total assets, under the SEC’s acquired-business guidance.

Important facts for investors to verify

• Separate ongoing operating performance from Cadbury acquisition effects, currency, the frozen-pizza gain, and acquisition and integration charges; review the company’s non-GAAP reconciliations.
• Track Cadbury integration progress, the timing and realization of targeted savings, total integration costs, and completion of the remaining-share acquisition and required divestitures.
• Assess the increased debt burden, rating changes, upcoming maturities, interest expense, covenant headroom, and the company’s ability to restore operating cash generation.
• Monitor execution against 2010 and 2011 guidance, including organic growth, Operating EPS, marketing investment and foreign-exchange impacts.
• Follow the resolution of tax examinations and uncertain tax positions, EU competition investigations, and Venezuelan economic and currency developments.