Kraft Foods Inc. — Form 10-Q summary
Filing identity: The supplied filing is for Kraft Foods Inc., for the quarter ended June 30, 2011, not Mondelez International, Inc. It reports the three and six months ended June 30, 2011, with comparisons to 2010. Amounts are U.S. dollars; financial statement amounts are in millions unless indicated otherwise.
Business context and reporting period
Kraft manufactured and marketed packaged foods across snacks, beverages, cheese, convenient meals and grocery products, operating in more than 75 countries and selling in approximately 170. Results cover continuing operations unless noted. Comparisons are affected by the 2010 Cadbury acquisition, the 2010 Frozen Pizza divestiture, the Starbucks packaged-coffee dispute and changes to accounting consolidation dates.
On August 4, 2011, after the quarter, the company announced its intent to separate into a global snacks company and a North American grocery company through a proposed tax-free spin-off, targeted before year-end 2012 and subject to approvals and other conditions.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net revenues | $13.878 billion | $12.253 billion | $26.451 billion | $23.571 billion |
| Operating income | $1.806 billion | $1.701 billion | $3.452 billion | $2.907 billion |
| Operating margin | 13.0% | 13.9% | 13.1% | 12.3% |
| Net earnings attributable to Kraft | $976 million | $937 million | $1.775 billion | $2.820 billion |
| Diluted EPS attributable to Kraft | $0.55 | $0.53 | $1.01 | $1.67 |
| Continuing-operations diluted EPS | $0.55 | $0.53 | $1.01 | $0.70 |
- Q2 reported revenue rose 13.3%; organic revenue increased 7.1%, reflecting 5.5 percentage points from pricing and 1.6 points from volume/mix. Reported growth also included currency and accounting-calendar benefits.
- First-half reported revenue rose 12.2%; organic revenue increased 5.9%. Higher pricing broadly offset higher input costs. First-half revenue also benefited from incremental Cadbury results, currency and calendar changes.
- Q2 operating income increased 6.2%, but margin fell to 13.0%. Management cited substantially higher raw-material costs, partly offset by pricing, currency and volume/mix; unfavorable hedge movements also weighed on results. First-half operating income rose 18.7%, including lower prior-year acquisition-related costs and other comparability effects.
- First-half net earnings and EPS were below 2010 primarily because the 2010 period included a $1.596 billion after-tax gain on the Frozen Pizza sale. Continuing-operations diluted EPS increased 44.3% year over year. Management’s non-GAAP Operating EPS was $0.62 for Q2 and $1.14 for the first half, versus $0.60 and $1.10, respectively, in 2010.
- First-half operating cash flow was $296 million, down from $779 million. Management attributed the decrease mainly to higher pension contributions, receivables timing and increased inventory, partly offset by higher earnings and the prior-year tax payment on the pizza divestiture. Capital expenditures were $655 million; full-year spending was expected to be about $1.9 billion.
- At June 30, cash was $2.267 billion; current assets were $17.496 billion and current liabilities $20.280 billion. The resulting current ratio was approximately 0.86. Inventories rose to $6.414 billion from $5.310 billion at year-end.
- Total debt was $29.6 billion, up from $28.7 billion at December 31, 2010; debt-to-capitalization was 0.43 versus 0.44. Debt due within twelve months was $4.9 billion. A new, undrawn $4.5 billion four-year revolving facility supported liquidity; the company reported covenant headroom and expected to meet its minimum-equity requirement.
- Dividends declared were $0.29 per share in Q2 and $0.58 for the first half; the stated annualized dividend rate was $1.16 per share.
Material changes and unusual items
- Accounting-calendar changes in 2011 added $360 million to Q2 revenue and $50 million to Q2 operating income, according to the filing. Management said it planned to reinvest the favorable operating-income impact. The changes also complicate year-over-year comparisons.
- Q2 gross profit was $4.871 billion versus $4.694 billion; gross margin was approximately 35.1% versus 38.3%. Cost of sales increased faster than revenue, reflecting input-cost pressure.
- Cadbury integration charges were $136 million in Q2 and $240 million in the first half. Cumulative charges were $897 million against an expected total of approximately $1.5 billion; expected annual cost savings were at least $750 million by the end of the third year after acquisition completion.
- Starbucks took control of the packaged-coffee business in March 2011, which Kraft disputed as a breach of contract. Arbitration was scheduled for April–May 2012; Kraft sought contractual remedies, including payment for the business. The filing does not quantify a likely recovery.
- First-half commodity costs were approximately $1.0 billion higher than a year earlier. Management expected elevated costs and volatility to continue through the rest of 2011.
- The first-half 2010 comparison included Cadbury acquisition effects and $1.644 billion of earnings and gain from discontinued operations, including the Frozen Pizza sale. These items make reported year-over-year net earnings and revenue comparisons less directly comparable.
Outlook, commentary and risks
Management raised 2011 targets to at least 5% organic net revenue growth, from at least 4%, and at least $2.25 Operating EPS, from at least $2.20. It expected better alignment between pricing and input costs, with volume remaining steady. These are company-defined non-GAAP measures, not GAAP revenue or EPS guidance.
Key disclosed risks include further commodity inflation and volatility, whether pricing can offset costs without weakening volume, competition and weak economic conditions, foreign-exchange exposure, indebtedness and refinancing needs, and the outcome of the Starbucks arbitration. The proposed spin-off could be delayed, changed or not completed; it requires regulatory and tax approvals, final board approval and other conditions, and could divert management attention and incur significant expense. The company reported $1.531 billion of unrecognized tax benefits at June 30; approximately $150–$200 million could decline over the next twelve months through settlements or statute expirations.
Important facts for investors to verify
- Confirm the correct registrant and filing: this document is Kraft Foods Inc.’s 2011 Form 10-Q, not a filing under the Mondelez International name.
- Reconcile reported growth with organic growth, particularly the effects of accounting-calendar changes, currency, Cadbury and divestitures.
- Assess whether pricing can sustainably recover the roughly $1.0 billion first-half increase in commodity costs without further volume or margin pressure.
- Review cash conversion, rising inventories, pension funding, the $4.9 billion of near-term maturities and sources of repayment.
- Track Cadbury integration spending against the remaining expected charges and delivery of the stated savings target.
- Monitor the Starbucks arbitration and the proposed spin-off’s approvals, terms and timing; neither outcome was assured in this filing.