Business context and reporting period
This is Kraft Foods Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2011, filed November 4, 2011. The filing identifies the registrant as Kraft Foods Inc.; it is not filed under the later Mondelez International name. Kraft manufactured and marketed packaged foods across snacks, beverages, cheese, convenient meals and grocery products.
Unless otherwise noted, financial amounts below are in millions of U.S. dollars. Comparisons are with the corresponding 2010 period.
Financial performance and position
| Metric | Third quarter 2011 | Nine months 2011 |
|---|---|---|
| Net revenues | $13,226; up 11.5% | $39,677; up 12.0% |
| Organic net revenue growth | 8.4% | 6.7% |
| Operating income | $1,698; up 11.8% | $5,150; up 16.4% |
| Operating margin | 12.8%; unchanged | 13.0%, versus 12.5% |
| Net earnings attributable to Kraft Foods | $922; up 22.3% | $2,697; down 24.5% |
| Diluted EPS attributable to Kraft Foods | $0.52, versus $0.43 | $1.52, versus $2.09 |
| Diluted EPS from continuing operations | $0.52 | $1.52, versus $1.13 |
Nine-month 2010 net earnings and EPS included $1,644 of earnings and gain from the discontinued North American frozen-pizza business, including a $1,596 after-tax sale gain. Thus, total EPS fell year over year while continuing-operations EPS increased. Q3 organic revenue growth reflected higher pricing (7.0 percentage points) and favorable volume/mix (1.4 points); pricing and volume/mix contributed 5.4 and 1.3 points, respectively, for the nine-month period.
Higher pricing more than offset higher input costs in the periods discussed, but gross margin was pressured: approximately 34.9% in Q3 versus 36.4% a year earlier, and 35.6% for nine months versus 37.0%. Management cited substantially higher raw-material costs. Nine-month commodity costs were about $1.7 billion above 2010, with elevated costs and volatility expected to continue through year-end.
For the nine months, operating cash flow was $1,665 versus $1,224; capital expenditures were $1,281 versus $1,020. Cash and cash equivalents were $1,976 at September 30, down from $2,481 at year-end 2010. Total debt was $28.9 billion, compared with $28.7 billion at year-end; debt-to-capitalization was 0.44. Current liabilities were $20,360 and current assets $17,329. The filing reports $4.8 billion of long-term debt due within 12 months, including approximately $2.7 billion in March 2012. Kraft cited a $4.5 billion revolving facility, with no amounts drawn, and said it expected cash from operations, commercial paper and additional debt issuance to fund maturities.
Declared dividends were $0.29 per share in Q3 and $0.87 for the nine months. The stated annualized dividend rate was $1.16 per share.
Material changes versus the prior comparable period
- Reported revenue growth included foreign-exchange benefits, acquisition effects, divestitures and changed reporting calendars. For nine months, foreign currency added $1,343, incremental Cadbury results added $697, and accounting-calendar changes added $316 to revenue; divestitures reduced revenue.
- Q3 operating income growth was 11.8%; management’s non-GAAP underlying operating income rose 12.2%. For nine months, reported operating income rose 16.4%, while underlying operating income rose 10.4%. These adjusted measures exclude specified acquisition and integration costs and are not GAAP measures.
- Pricing was partly offset by higher input costs. Q3 segment operating income declined in U.S. Beverages and U.S. Cheese; nine-month declines also occurred in U.S. Snacks. Developing Markets posted strong growth, with Q3 revenue up 20.3% and segment operating income up 57.3%.
- Cadbury integration charges were $112 in Q3 and $352 for nine months, versus $92 and $284, respectively. Approximately $1.0 billion of the expected $1.5 billion total integration charges had been incurred; the related accrual was $333 at September 30.
- The Starbucks packaged-coffee business ceased to be included after March 1, 2011, following Starbucks’ assumption of control amid a contract dispute. This reduced comparative segment revenue and operating income.
Outlook, commentary, risks and unusual items
- Kraft raised its 2011 organic net revenue growth outlook from at least 5% to at least 6%, and its Operating EPS guidance from at least $2.25 to at least $2.27. Management expected continued operating momentum and a neutral currency impact in Q4, while noting currency forecasting difficulty. Operating EPS is a company-defined non-GAAP measure.
- The board intended to separate the company into a global snacks business and a North American grocery business through a tax-free spin-off, targeting completion before year-end 2012. Completion depended on regulatory approvals, a favorable IRS tax ruling, agreements and final board approval; timing and terms were not assured. Kraft warned of significant costs and management distraction.
- The Starbucks dispute was in arbitration in Chicago. Kraft sought remedies including fair market value plus a contractual premium; Starbucks counterclaimed for unspecified damages. The filing did not provide a clear estimate of potential exposure or recovery.
- Management identified continued commodity-cost volatility, competition, a weak economic environment, indebtedness, global operating risks and tax-law changes among factors that could affect results. The filing said ordinary-course legal matters were not expected to have a material effect, but outcomes could not be predicted with certainty.
- Q3 and nine-month effective tax rates were 27.2% and 29.5%, respectively, favorably affected by discrete tax items, including U.K. tax-rate changes and valuation-allowance reversals. Unrecognized tax benefits were $1,526 at September 30; Kraft estimated $160–$200 could decrease over the next 12 months through settlements or statute expirations.
Most important facts for investors to verify
- Whether the proposed spin-off received approvals, remained tax-free, and was completed on the anticipated terms and timeline.
- Whether pricing continued to offset commodity inflation without further volume or gross-margin deterioration.
- Execution of the $2.7 billion March 2012 maturity and the remaining near-term debt repayments; liquidity and covenant compliance.
- Developments and financial consequences of the Starbucks arbitration and counterclaim.
- Progress and remaining costs of the Cadbury integration, and whether expected savings and revenue synergies were achieved.
- How reported growth compares with organic growth after accounting for foreign exchange, acquisition/divestiture effects and reporting-calendar changes.