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, 2006
		OR
o		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

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

 

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   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   x

Accelerated filer   o

Non-accelerated filer   o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   o   No   x

At October 31, 2006, there were 463,780,369 shares of the registrant’s Class A Common Stock outstanding, and 1,180,000,000 shares of the registrant’s Class B Common Stock outstanding.

 

KRAFT FOODS INC.

TABLE OF CONTENTS

				Page No.
PART I -		FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005		3 - 4
		Condensed Consolidated Statements of Earnings for the Nine Months Ended September 30, 2006 and 2005		5
		Three Months Ended September 30, 2006 and 2005		6
		Condensed Consolidated Statements of Shareholders’ Equity for the Year Ended December 31, 2005 and the Nine Months Ended September 30, 2006		7
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005		8 - 9
		Notes to Condensed Consolidated Financial Statements		10 - 29
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		30 - 55
Item 4.		Controls and Procedures		56
PART II -		OTHER INFORMATION
Item 1.		Legal Proceedings		57
Item 1A.		Risk Factors		58
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		58
Item 6.		Exhibits		59
Signature				60

 

2

 

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

Kraft Foods Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)

		September 30, 2006			December 31, 2005
ASSETS
Cash and cash equivalents		$	655		$	316
Receivables (less allowances of $84 in 2006 and $92 in 2005)		3,573			3,385
Inventories:
Raw materials		1,554			1,363
Finished product		2,303			1,980
		3,857			3,343
Deferred income taxes		549			879
Other current assets		325			230
Total current assets		8,959			8,153
Property, plant and equipment, at cost		17,363			16,598
Less accumulated depreciation		7,554			6,781
		9,809			9,817
Goodwill		25,740			24,648
Other intangible assets, net		10,075			10,516
Prepaid pension assets		3,632			3,617
Other assets		625			877
TOTAL ASSETS		$	58,840		$	57,628

 

 

See notes to condensed consolidated financial statements.

Continued

3

 

Kraft Foods Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars)
(Unaudited)

		September 30, 2006			December 31, 2005
LIABILITIES
Short-term borrowings		$	1,046		$	805
Current portion of long-term debt		2,666			1,268
Due to Altria Group, Inc. and affiliates		475			652
Accounts payable		2,376			2,270
Accrued liabilities:
Marketing		1,462			1,529
Employment costs		746			625
Other		1,648			1,338
Income taxes		452			237
Total current liabilities		10,871			8,724
Long-term debt		7,081			8,475
Deferred income taxes		5,689			6,067
Accrued postretirement health care costs		1,994			1,931
Other liabilities		2,807			2,838
Total liabilities		28,442			28,035
Contingencies (Note 8)
SHAREHOLDERS’ EQUITY
Class A common stock, no par value (555,000,000 shares issued in 2006 and 2005)
Class B common stock, no par value (1,180,000,000 shares issued and outstanding in 2006 and 2005)
Additional paid-in capital		23,580			23,835
Earnings reinvested in the business		10,914			9,453
Accumulated other comprehensive losses (including currency translation of $(824) in 2006 and $(1,290) in 2005)		(1,256)			(1,663)
		33,238			31,625
Less cost of repurchased stock (90,844,488 Class A shares in 2006 and 65,119,245 Class A shares in 2005)		(2,840)			(2,032)
Total shareholders’ equity		30,398			29,593
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	58,840		$	57,628

 

See notes to condensed consolidated financial statments.

4

 

Kraft Foods Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)

		For the Nine Months Ended September 30,
		2006			2005
Net revenues		$	24,985		$	24,450
Cost of sales		15,869			15,580
Gross profit		9,116			8,870
Marketing, administration and research costs		5,242			5,216
Asset impairment and exit costs		553			205
Gain on redemption of United Biscuits investment		(251		)
Losses (gains) on sales of businesses, net		14			(115		)
Amortization of intangibles		6			9
Operating income		3,552			3,555
Interest and other debt expense, net		377			489
Earnings from continuing operations before income taxes and minority interest		3,175			3,066
Provision for income taxes		735			932
Earnings from continuing operations before minority interest		2,440			2,134
Minority interest in earnings from continuing operations, net		4			3
Earnings from continuing operations		2,436			2,131
Loss from discontinued operations, net of income taxes					(272		)
Net earnings		$	2,436		$	1,859
Per share data:
Basic earnings per share:
Continuing operations		$	1.48		$	1.26
Discontinued operations					(0.16		)
Net earnings		$	1.48		$	1.10
Diluted earnings per share:
Continuing operations		$	1.47		$	1.26
Discontinued operations					(0.16		)
Net earnings		$	1.47		$	1.10
Dividends declared		$	0.71		$	0.64

 

See notes to condensed consolidated financial statements.

5

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,
		2006			2005
Net revenues		$	8,243		$	8,057
Cost of sales		5,243			5,201
Gross profit		3,000			2,856
Marketing, administration and research costs		1,765			1,678
Asset impairment and exit costs		125			26
Gain on redemption of United Biscuits investment		(251		)
Losses on sales of businesses		3
Amortization of intangibles		1			4
Operating income		1,357			1,148
Interest and other debt expense, net		134			139
Earnings before income taxes and minority interest		1,223			1,009
Provision for income taxes		473			334
Earnings before minority interest		750			675
Minority interest in earnings, net		2			1
Net earnings		$	748		$	674
Per share data:
Basic earnings per share		$	0.46		$	0.40
Diluted earnings per share		$	0.45		$	0.40
Dividends declared		$	0.25		$	0.23

 

See notes to condensed consolidated financial statments.

6

Kraft Foods Inc. and Subsidiaries
Condensed Consolidated Statements of Shareholders’ Equity
For the Year Ended December 31, 2005 and
the Nine Months Ended September 30, 2006
(in millions of dollars, except per share data)
(Unaudited)

											Accumulated Other Comprehensive Earnings/(Losses)
		Class A and B Common Stock			Additional Paid-in Capital			Earnings Reinvested in the Business			Currency Translation Adjustments			Other			Total			Cost of Repurchased Stock			Total Share- holders’ Equity
Balances, January 1, 2005		$	—		$	23,762		$	8,304		$	(890	)	$	(315	)	$	(1,205	)	$	(950	)	$	29,911
Comprehensive earnings:
Net earnings								2,632															2,632
Other comprehensive losses, net of income taxes:
Currency translation adjustments											(400		)				(400		)				(400		)
Additional minimum pension liability														(48		)	(48		)				(48		)
Change in fair value of derivatives accounted for as hedges														(10		)	(10		)				(10		)
Total other comprehensive losses																							(458		)
Total comprehensive earnings																							2,174
Exercise of stock options and issuance of other stock awards					52			(12		)										118			158
Cash dividends declared ($0.87 per share)								(1,471		)													(1,471		)
Class A common stock repurchased																				(1,200		)	(1,200		)
Other					21																		21
Balances, December 31, 2005		—			23,835			9,453			(1,290		)	(373		)	(1,663		)	(2,032		)	29,593
Comprehensive earnings:
Net earnings								2,436															2,436
Other comprehensive earnings (losses), net of income taxes:
Currency translation adjustments											466						466						466
Additional minimum pension liability														(25		)	(25		)				(25		)
Change in fair value of derivatives accounted for as hedges														(34		)	(34		)				(34		)
Total other comprehensive earnings																							407
Total comprehensive earnings																							2,843
Exercise of stock options and issuance of other stock awards					(255		)	202												129			76
Cash dividends declared ($0.71 per share)								(1,177		)													(1,177		)
Class A common stock repurchased																				(937		)	(937		)
Balances, September 30, 2006		$	—		$	23,580		$	10,914		$	(824	)	$	(432	)	$	(1,256	)	$	(2,840	)	$	30,398

 

Total comprehensive earnings were $697 million and $671 million, respectively, for the quarters ended September 30, 2006 and 2005 and $1,628 million for the first nine months of 2005.

See notes to condensed consolidated financial statements.

7

Kraft Foods Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)

		For the Nine Months Ended
		September 30,
		2006			2005
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings		$	2,436		$	1,859
Adjustments to reconcile net earnings to operating cash flows:
Depreciation and amortization		654			651
Deferred income tax benefit		(29		)	(280		)
Integration costs, net of cash paid					(1		)
Gain on redemption of United Biscuits investment		(251		)
Losses (gains) on sales of businesses, net		14			(115		)
Loss on sale of discontinued operations					32
Asset impairment and exit costs, net of cash paid		389			86
Cash effects of changes, net of the effects from acquired and divested companies:
Receivables, net		38			163
Inventories		(526		)	(409		)
Accounts payable		84			(30		)
Income taxes		130			212
Amounts due to Altria Group, Inc. and affiliates		(214		)	96
Other working capital items		(139		)	(308		)
Change in pension assets and postretirement liabilities, net		75			(55		)
Other		135			137
Net cash provided by operating activities		2,796			2,038
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Capital expenditures		(687		)	(784		)
Proceeds from sales of businesses		674			1,652
Other		82			21
Net cash provided by investing activities		69			889

 

See notes to condensed consolidated financial statements.

Continued

8

Kraft Foods Inc. and Subsidiaries
  Condensed Consolidated Statements of Cash Flows (Continued)
(in millions of dollars)
(Unaudited)

		For the Nine Months Ended
		September 30,
		2006			2005
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Net repayment of short-term borrowings		$	(317	)	$	(772	)
Long-term debt proceeds		49			52
Long-term debt repaid		(57		)	(761		)
Increase in amounts due to Altria Group, Inc. and affiliates		9			170
Repurchase of Class A common stock		(943		)	(783		)
Dividends paid		(1,150		)	(1,049		)
Other		(147		)	165
Net cash used in financing activities		(2,556		)	(2,978		)
Effect of exchange rate changes on cash and cash equivalents		30			4
Cash and cash equivalents:
Increase (decrease)		339			(47		)
Balance at beginning of period		316			282
Balance at end of period		$	655		$	235

 

See notes to condensed consolidated financial statements.

9

Kraft Foods Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 1. Accounting Policies:

Basis of Presentation

The interim condensed consolidated financial statements of Kraft Foods Inc. (“Kraft”), together with its subsidiaries (collectively referred to as the “Company”), are unaudited. It is the opinion of the Company’s management that all adjustments necessary for a fair statement of the interim results presented have been reflected therein. All such adjustments were of a normal recurring nature. Net revenues and net earnings for any interim period are not necessarily indicative of results that may be expected for the entire year.

These statements should be read in conjunction with the Company’s consolidated financial statements and related notes, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

In June 2005, the Company sold substantially all of its sugar confectionery business for pre-tax proceeds of approximately $1.4 billion. The Company has reflected the results of its sugar confectionery business prior to the closing date as discontinued operations on the condensed consolidated statements of earnings.

In October 2005, the Company announced that, effective January 1, 2006, its Canadian business will be realigned to better integrate it into the Company’s North American business by product category. Beginning in the first quarter of 2006, the operating results of the Canadian business are being reported throughout the North American food segments. In addition, in the first quarter of 2006, the Company’s international businesses were realigned to reflect the reorganization announced within Europe in November 2005. The two revised international segments, which are reflected in these condensed consolidated financial statements and notes, are European Union; and Developing Markets, Oceania & North Asia, the latter to reflect the Company’s increased management focus on developing markets. Accordingly, prior period segment results have been restated.

Stock-Based Compensation Expense

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment,” (“SFAS No. 123(R)”) using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service periods for awards expected to vest. The fair value of restricted stock and rights to receive shares of stock is determined based on the number of shares granted and the market value at date of grant. The fair value of stock options is determined using a modified Black-Scholes methodology. The impact of adoption was not material.

The adoption of SFAS No. 123(R) in the first quarter of 2006 resulted in a cumulative effect gain of $6 million, which is net of $3 million in taxes, in the condensed consolidated statements of earnings for the nine months ended September 30, 2006. This gain resulted from the impact of estimating future forfeitures on restricted stock and rights to receive shares of stock in the determination of periodic expense for unvested awards, rather than recording forfeitures only when they occur. The gross cumulative effect was recorded in marketing, administration and research costs in the first quarter of 2006.

10

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Kraft Foods Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company previously applied the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and provided the pro forma disclosures required by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). No compensation expense for employee stock options was reflected in net earnings in 2005, as all stock options granted under those plans had an exercise price equal to the market value of the common stock on the date of the grant. Historical condensed consolidated statements of earnings already include the compensation expense for restricted stock and rights to receive shares of stock. The following table illustrates the effect on net earnings and earnings per share (“EPS”) if the Company had applied the fair value recognition provisions of SFAS No. 123 to measure stock-based compensation expense for stock option awards in 2005:

 

		For the Nine Months			For the Three Months
		Ended September 30, 2005			Ended September 30, 2005
		(in millions, except per share data)
Net earnings, as reported		$	1,859		$	674
Deduct:
Total stock-based employee compensation expense determined under fair value method for all stock option awards, net of related tax effects		6			2
Pro forma net earnings		$	1,853		$	672
Earnings per share:
Basic – as reported		$	1.10		$	0.40
Basic – pro forma		$	1.10		$	0.40
Diluted – as reported		$	1.10		$	0.40
Diluted – pro forma		$	1.09		$	0.40

 

The Company elected to calculate the initial pool of tax benefits resulting from tax deductions in excess of the stock-based employee compensation expense recognized in the statement of earnings under Financial Accounting Standards Board (“FASB”) Staff Position 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” Under SFAS No. 123(R), tax shortfalls occur when actual tax deductible compensation expense is less than cumulative stock-based compensation expense recognized in the financial statements. Tax shortfalls of $9 million were recognized for the nine months ended September 30, 2006, and were recorded in additional paid-in capital.

Note 2. Asset Impairment, Exit and Implementation Costs:

Restructuring Program:

In January 2004, the Company announced a three-year restructuring program with the objectives of leveraging the Company’s global scale, realigning and lowering its cost structure, and optimizing capacity utilization. In January 2006, the Company announced plans to expand its restructuring efforts through 2008. The entire restructuring program is expected to result in $3.7 billion in pre-tax charges reflecting asset disposals, severance and implementation costs. As part of this program, the Company anticipates the closure of up to 40 facilities and the elimination of approximately 14,000 positions. Approximately $2.3 billion of the $3.7 billion in pre-tax charges are expected to require cash payments. Pre-tax restructuring program charges during 2006 are expected to be approximately $1 billion, including $496 million incurred for the nine months ended September 30, 2006. Total pre-tax restructuring charges incurred since the inception of the program in January 2004 were $1.4 billion.

 

11

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Kraft Foods Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

During the second quarter of 2006, the Company announced a seven-year, $1.7 billion agreement to receive information technology services from Electronic Data Systems (“EDS”). The agreement, which includes data centers, web hosting, telecommunications and IT workplace services, began on June 1, 2006. Pursuant to the agreement, approximately 670 employees, who provided certain IT support to the Company, were transitioned to EDS. As a result, the Company incurred pre-tax asset impairment and exit costs of $49 million and $46 million, and implementation costs of $30 million and $19 million, related to the transition for the nine months and three months ended September 30, 2006, respectively. These costs were included in the pre-tax restructuring program charges discussed above.

Restructuring Costs:

During the nine months and three months ended September 30, 2006, pre-tax charges under the restructuring program of $443 million and $125 million, respectively, were recorded as asset impairment and exit costs on the condensed consolidated statements of earnings. During the nine months and three months ended September 30, 2005, pre-tax charges under the restructuring program of $112 million and $26 million, respectively, were recorded as asset impairment and exit costs on the condensed consolidated statements of earnings. The pre-tax charges for the nine months ended September 30, 2006 resulted from the announcement of the closing of seven plants, for a total of 26 since January 2004, and the continuation of a number of workforce reduction programs. Approximately $243 million of the pre-tax charges incurred during the first nine months of 2006 will require cash payments.

Pre-tax restructuring liability activity for the nine months ended September 30, 2006 was as follows:

 

Severance costs in the above schedule, which relate to the workforce reduction programs, include the cost of related benefits. Specific programs announced since 2004, as part of the overall restructuring program, will result in the elimination of approximately 9,200 positions. At September 30, 2006, approximately 7,800 of these positions have been eliminated. Asset write-downs relate to the impairment of assets caused by the plant closings and related activity. Other costs incurred relate primarily to contract termination costs associated with the plant closings and the termination of leasing agreements. Severance costs taken against assets relate to incremental pension costs, which reduce prepaid pension assets.

 

12

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Kraft Foods Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Implementation Costs:

The Company recorded pre-tax implementation costs associated with the restructuring program. These costs include the discontinuance of certain product lines and incremental costs related to the integration and streamlining of functions and closure of facilities. Substantially all implementation costs incurred in 2006 will require cash payments. These costs were recorded on the condensed consolidated statements of earnings as follows:

 

Asset Impairment Charges:

During the third quarter of 2006, the Company completed the sale of its pet snacks brand and assets for $580 million and recorded tax expense of $57 million related to the sale. The Company incurred a pre-tax asset impairment charge of $86 million in the first quarter of 2006 in recognition of this sale. The charge, which included the write-off of a portion of the associated goodwill and intangible and fixed assets, was recorded as asset impairment and exit costs on the condensed consolidated statement of earnings.

During the first quarter of 2006, the Company completed its annual review of goodwill and intangible assets and recorded non-cash pre-tax charges of $24 million related to an intangible asset impairment for biscuits assets in Egypt and hot cereal assets in the United States. These charges were recorded as asset impairment and exit costs on the condensed consolidated statement of earnings. During the first quarter of 2005, the Company completed its annual review of goodwill and intangible assets and no charges resulted from this review.

During the second quarter of 2005, the Company completed the sale of its fruit snacks assets. The Company incurred a pre-tax asset impairment charge of $93 million in the first quarter of 2005 in recognition of the sale. The charge, which included the write-off of all associated intangible assets, was recorded as asset impairment and exit costs on the condensed consolidated statement of earnings.

 

13

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Kraft Foods Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Total:

The pre-tax asset impairment, exit and implementation costs discussed above, for the nine months and three months ended September 30, 2006 and 2005, were included in the operating companies income of the following segments:

		For the Nine Months Ended September 30, 2006
		Restructuring Costs			Asset Impairment			Total Asset Impairment and Exit Costs			Implementation Costs			Total
		(in millions)
North America Beverages		$	17		$	—		$	17		$	6		$	23
North America Cheese & Foodservice		80						80			7			87
North America Convenient Meals		74						74			9			83
North America Grocery		18						18			7			25
North America Snacks & Cereals		28			99			127			9			136
European Union		161						161			11			172
Developing Markets, Oceania & North Asia		65			11			76			4			80
Total		$	443		$	110		$	553		$	53		$	606

 

		For the Nine Months Ended September 30, 2005
		Restructuring Costs			Asset Impairment			Total Asset Impairment and Exit Costs			Implementation Costs			Total
		(in millions)
North America Beverages		$	3		$	—		$	3		$	5		$	8
North America Cheese & Foodservice		9						9			6			15
North America Convenient Meals		2						2			2			4
North America Grocery		12			93			105			1			106
North America Snacks & Cereals		5						5			29			34
European Union		67						67			14			81
Developing Markets, Oceania & North Asia		14						14			4			18
Total		$	112		$	93		$	205		$	61		$	266

 

14