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KRFT > SEC Filings for KRFT > Form 10-K on 21-Mar-2013All Recent SEC Filings

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Form 10-K for KRAFT FOODS GROUP, INC.


21-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including the consolidated financial statements and related notes contained in Item 8.

Description of the Company

We operate one of the largest consumer packaged food and beverage companies in North America. We manufacture and market refrigerated meals, refreshment beverages and coffee, cheese, and other grocery products, primarily in the United States and Canada. Our product categories span all major meal occasions, both at home and in foodservice locations.

Spin-Off Transaction

Prior to October 1, 2012, we were a wholly owned subsidiary of Mondel?z International. In connection with the Spin-Off, Mondel?z International undertook a series of transactions to separate net assets and entities. As a result of these transactions, Mondel?z International now holds the global snacks business, and we, Kraft Foods Group, now hold the North American grocery business.


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To effect the Spin-Off, Mondel?z International distributed 592 million shares of Kraft Foods Group common stock to Mondel?z International's shareholders on October 1, 2012. Holders of Mondel?z International common stock received one share of Kraft Foods Group common stock for every three shares of Mondel?z International common stock held on September 19, 2012. Mondel?z International structured the Distribution to be tax free to its U.S. shareholders for U.S. federal income tax purposes. As a result of the Spin-Off, we now operate as an independent, publicly traded company.

Discussion and Analysis

Items Affecting Comparability of Financial Results

Principles of Consolidation

Prior to the Spin-Off on October 1, 2012, our financial statements were prepared on a stand-alone basis and were derived from the consolidated financial statements and accounting records of Mondel?z International. Our financial statements included certain expenses of Mondel?z International which were allocated to us for certain functions. These allocations were not necessarily indicative of the actual expenses we would have incurred as an independent public company or of the costs we will incur in the future, and may differ substantially from the allocations we agreed to in the various separation agreements.

In December 2012, we changed our fiscal year end from December 31 to the last Saturday in December. Our 2012 fiscal year ended on December 29, 2012. For 2011 and 2010, our fiscal years ended on December 31 of that year.

See Critical Accounting Policies - Principles of Consolidation later in this section for further information about our allocations of expenses and change in fiscal year.

Debt

On May 18, 2012, we entered into a $3.0 billion five-year senior unsecured revolving credit facility in connection with the Spin-Off. The agreement expires on May 17, 2017. On June 4, 2012, we issued $6.0 billion of senior unsecured notes with a weighted average interest rate of 3.938% and transferred the net proceeds of $5.9 billion to Mondel?z International. In addition, Mondel?z International completed a debt exchange in which $3.6 billion of Mondel?z International debt was exchanged for our debt as part of our Spin-Off-related capitalization plan on July 18, 2012. No cash was generated from the exchange. On October 1, 2012, Mondel?z International also transferred approximately $0.4 billion of Mondel?z International 7.550% senior unsecured notes to us to complete the key elements of the debt migration plan in connection with the Spin-Off. At December 31, 2011, our total debt of $35 million consisted of capital leases.

Postemployment Benefit Plans

On October 1, 2012, Mondel?z International transferred to us certain postemployment benefit plan assets and liabilities associated with our active and retired and other former employees. Additionally, we assumed certain net benefit plan liabilities for most of the Mondel?z International retired and other former North American employees as of October 1, 2012. We assumed net benefit plan liabilities of $5.5 billion from Mondel?z International, which was in addition to the $0.1 billion of net benefit plan liabilities we had previously reported in our historical financial statements, for a total liability of $5.6 billion on October 1, 2012.

For more information, see Critical Accounting Policies - Postemployment Benefit Plans later in this section.

Restructuring Program

On October 29, 2012, our Board of Directors approved a $650 million restructuring program consisting of restructuring costs, implementation costs, and Spin-Off transition costs ("Restructuring Program"). The Restructuring Program is part of, and its costs are consistent with, a restructuring program previously announced by Mondel?z International prior to the Spin-Off. The primary objective of the Restructuring Program activities is to ensure that we are set up to operate efficiently and execute our business strategy as a stand-alone company. Approximately one-half of the total Restructuring Program costs are expected to result in cash expenditures. We have incurred $303 million of Restructuring Program costs, of which $170 million was incurred prior to the Spin-Off. Of the total Restructuring Program costs incurred to date, $153 million were cash expenditures in 2012, of which $32 million was incurred prior to the Spin-Off. We expect to incur up to $300 million of Restructuring Program costs in 2013. In addition to approving the Restructuring Program, our Board approved related capital expenditures of approximately $200 million. We expect to complete the program by the end of 2014. See Note 6, Restructuring Program, for additional information.


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Starbucks CPG Business

On March 1, 2011, Starbucks took control of the Starbucks CPG business in grocery stores and other channels. Starbucks did so without our authorization and in what we contend is a violation and breach of our license and supply agreement with Starbucks related to the Starbucks CPG business. The dispute is in arbitration in Chicago, Illinois. While we remain the named party in the proceeding, under the Separation and Distribution Agreement between Mondel?z International and us, we will direct any recovery we are awarded in the arbitration proceeding to Mondel?z International. Mondel?z International will reimburse us for any costs and expenses we incur in connection with the arbitration.

Divestitures

Pizza Divestiture:

On March 1, 2010, we completed the sale of the assets of our North American frozen pizza business ("Frozen Pizza") to Nestlé USA, Inc. ("Nestlé") for $3.7 billion. Our Frozen Pizza business was a component of our Refrigerated Meals and International & Foodservice segments. The sale included the DiGiorno, Tombstone, and Jack's brands in the U.S., the Delissio brand in Canada and the California Pizza Kitchen trademark license. It also included two Wisconsin manufacturing facilities (Medford and Little Chute) and the leases for the pizza depots and delivery trucks. Approximately 3,600 of our employees transferred with the business to Nestlé. Accordingly, the results of our Frozen Pizza business have been reflected as discontinued operations on the consolidated statement of earnings for 2010. As a result of the divestiture, we recorded a gain on discontinued operations of $1,596 million, net of taxes, in 2010.

Pursuant to our transition services agreement with Nestlé, we agreed to provide certain sales, co-manufacturing, distribution, information technology, accounting, and finance services to Nestlé for up to two years. As of December 31, 2011, these service agreements were substantially complete.

Provision for Income Taxes

Our effective tax rate was 33.1% in 2012, 38.3% in 2011, and 37.0% in 2010. Our 2012 effective tax rate included net tax benefits of $33 million from discrete one-time events, primarily from various U.S. federal, foreign, and state tax audit developments during the year.

Our 2011 effective tax rate included net tax costs of $52 million, primarily from various U.S. federal and U.S. state tax audit developments during the year as well as the revaluation of state deferred tax assets and liabilities resulting from state tax legislation enacted in 2011.

Our 2010 effective tax rate included net tax costs of $32 million, primarily due to a $79 million write-off of deferred tax assets as a result of the U.S. health care legislation enacted in March 2010, partially offset by the federal and state impacts from the favorable resolution of a federal tax audit.

Consolidated Results of Operations

The following discussion compares our consolidated results of operations for 2012 with 2011 and for 2011 with 2010.

Summary of Results and Other Significant Highlights

• Net revenues decreased 1.7% to $18.3 billion in 2012 and increased 4.8% to $18.7 billion in 2011.

• Organic Net Revenues, a non-GAAP financial measure we use to evaluate our underlying results (see our reconciliation with net revenues and a discussion of our Non-GAAP Financial Measures later in this section), remained essentially flat in 2012 at $18.2 billion. Organic Net Revenues increased 5.7% to $18.1 billion in 2011 compared to 2010.

• Diluted earnings per share ("EPS") decreased 8.3% to $2.75 in 2012 as compared to $3.00 from the prior year. Diluted EPS and the average number of common shares outstanding as of December 31, 2011 were retrospectively restated for the number of Kraft Foods Group shares outstanding immediately following the Spin-Off.

• Our total debt increased approximately $9.9 billion in 2012 compared to 2011 due to a $6.0 billion debt issuance, $3.6 billion debt exchange with Mondel?z International debt and the transfer of $0.4 billion of debt from Mondel?z International to us in connection with the Spin-Off, partially offset by capital lease payments.


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• Our pension, postretirement and other postemployment (collectively "postemployment") net benefit obligations increased $5.6 billion as of December 29, 2012 compared to the prior year due primarily to the transfer of $5.5 billion of net postemployment benefit obligations from Mondel?z International on October 1, 2012 in connection with the Spin-Off.

2012 compared with 2011

                                              For the Years Ended
                                      December 29,             December 31,
                                          2012                     2011              $ change           % change
                                      (in millions, except per share data)

Net revenues                       $            18,339        $        18,655       $      (316 )            (1.7% )

Operating income                   $             2,670        $         2,828       $      (158 )            (5.6% )

Net earnings                       $             1,642        $         1,775       $      (133 )            (7.5% )

Diluted EPS                        $              2.75        $          3.00       $     (0.25 )            (8.3% )

Net Revenues - Net revenues decreased $316 million (1.7%) to $18,339 million in 2012, and Organic Net Revenues(1) increased $9 million (0.1%) to $18,247 million as follows:

                                             For the Years Ended
                                      December 29,         December 31,
                                          2012                 2011             $ Change          % Change
                                                (in millions)
Net revenues                         $       18,339       $       18,655       $     (316)            (1.7)%
Impact of divestitures                            -                 (91)                91             0.5pp
Impact of the 53rd week of
shipments in 2011                                 -                (226)               226             1.3pp
Impact of foreign currency                       22                    -                22             0.1pp
Sales to Mondel?z International               (114)                (100)              (14)           (0.1)pp

Organic Net Revenues (1)             $       18,247       $       18,238       $         9              0.1%

Volume/mix                                                                     $     (508)           (2.7)pp
Net pricing                                                                    $       517             2.8pp

(1) "Organic Net Revenues" is a non-GAAP financial measure. Please see the Non-GAAP Financial Measures section at the end of this item.

Organic Net Revenues increased slightly as the impact of higher net pricing was generally offset by unfavorable volume/mix. Higher net pricing, including the impact of pricing from prior periods, was realized across all reportable business segments as we increased pricing to offset higher commodity costs. Unfavorable volume/mix reflected lower shipments (including a detriment of approximately 0.9 pp due to product pruning and 0.7 pp due to customer trade inventory reductions). Sales to Mondel?z International increased net revenues by $14 million while unfavorable foreign currency lowered net revenues by $22 million, due to the strength of the U.S. dollar versus the Canadian dollar. In 2011, net revenues included a 53rd week of shipments that added $226 million to net revenues and $91 million related to the impact of divestitures (including for reporting purposes the Starbucks CPG business).

Operating Income - Operating income decreased $158 million (5.6%) to $2,670 million in 2012, due to the following:

                                                        Operating
                                                         Income                   Change
                                                      (in millions)         (percentage point)

Operating Income for the Year Ended December 31,
2011                                                 $         2,828
Higher net pricing                                               517                     18.4pp
Higher product costs                                            (42)                    (1.5)pp
Unfavorable volume/mix                                         (220)                    (7.8)pp
Lower selling, general and administrative
expenses                                                          51                      1.8pp
Unfavorable foreign currency                                     (5)                    (0.2)pp
Impact of the 53rd week of shipments in 2011                    (62)                    (2.4)pp
Restructuring Program costs                                    (303)                   (10.3)pp
Change in market-based impacts to postemployment
benefit plans                                                  (153)                    (5.5)pp
Change in unrealized gains/losses on hedging
activities                                                        77                      2.7pp
Decreased operating income from divestitures                    (20)                    (0.8)pp
Other, net                                                         2                          -

Operating Income for the Year Ended December 29,
2012                                                 $         2,670                     (5.6)%


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Higher net pricing outpaced increased product costs during 2012. The increase in product costs was due to higher commodity costs, partially offset by lower manufacturing costs (driven by net productivity). Unfavorable volume/mix was reported in all segments, reflecting product pruning, customer trade inventory reductions, and the impact of higher pricing. Despite an increase in advertising expense, total selling, general and administrative expenses decreased $51 million in 2012 from 2011 excluding Restructuring Program costs and the impacts of foreign currency, divestitures, and the 53rd week of shipments in 2011. Unfavorable foreign currency decreased operating income by $5 million, due to the strength of the U.S. dollar versus the Canadian dollar. The 53rd week of shipments in 2011 had an unfavorable year-over-year impact of $62 million. We recorded Restructuring Program costs of $303 million in 2012, consisting of restructuring charges of $141 million, implementation costs of $131 million, and Spin-Off transition costs of $31 million. The change in market-based impacts to postemployment benefit plans decreased operating income by $153 million, as we recorded a mark-to-market expense of $223 million in 2012 (which consists of a $594 million impact from changes in actuarial assumptions, partially offset by $371 million of gains on pension assets), versus a mark-to-market expense of $70 million in 2011. The change in unrealized gains/losses on hedging activities increased operating income by $77 million, as we recognized gains of $13 million in 2012, versus losses of $64 million in 2011. The impact of divestitures (primarily the Starbucks CPG business cessation) decreased operating income by $20 million.

Net Earnings and Diluted EPS - Net earnings of $1,642 million decreased by $133 million (7.5%) in 2012. Diluted EPS were $2.75 in 2012, down 8.3% from $3.00 in 2011, due to the following:

                                                                     Diluted EPS

    Diluted EPS for the Year Ended December 31, 2011                 $       3.00
    Increases in operations                                                  0.33
    Impact of the 53rd week of shipments in 2011                            (0.07 )
    Restructuring Program costs                                             (0.32 )
    Change in market-based impacts to postemployment benefit plans          (0.15 )
    Change in unrealized gains/losses from hedging activities                0.08
    Impact of divestitures                                                  (0.02 )
    Royalty income from Mondel?z International                              (0.01 )
    Higher interest and other expense, net                                  (0.27 )
    Changes in taxes                                                         0.21
    Shares outstanding                                                      (0.03 )

    Diluted EPS for the Year Ended December 29, 2012                 $       2.75

The increase in interest and other expense, net was due to the $6.0 billion debt issuance in June 2012, the $3.6 billion debt exchange in July 2012, and the $0.4 billion transfer of debt from Mondel?z International in October 2012.

Diluted EPS for the year ended December 29, 2012 decreased $0.03 per share due to the dilutive impact of stock-based awards outstanding. Diluted EPS for the year ended December 31, 2011 did not include the impact of these awards as they were not outstanding prior to the Spin-Off.

The market-based impacts to postemployment benefit plans reflect our new strategy to follow a mark-to-market accounting policy for our postemployment benefit obligations. For a description of this accounting policy change, see Critical Accounting Policies - Postemployment Benefit Plans later in this section.

2011 compared with 2010

                                               For the Years Ended
                                       December 31,             December 31,
                                           2011                     2010              $ change           % change
                                       (in millions, except per share data)

Net revenues                        $            18,655        $        17,797       $       858               4.8%

Operating income                                  2,828                  2,965              (137 )            (4.6% )

Earnings from continuing
operations                                        1,775                  1,890              (115 )            (6.1% )

Net earnings                                      1,775                  3,534            (1,759 )           (49.8% )

Diluted EPS from continuing
operations                                         3.00                   3.20             (0.20 )            (6.0% )

Diluted EPS                                        3.00                   5.98             (2.98 )           (49.8% )


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Net Revenues - Net revenues increased $858 million (4.8%) to $18,655 million in 2011, and Organic Net Revenues (1) increased $976 million (5.7%) to $18,147 million as follows:

                                            For the Years Ended
                                     December 31,          December 31,
                                         2011                  2010              $ Change           % Change
                                               (in millions)
Net revenues                        $       18,655        $       17,797        $       858               4.8%
Impact of divestitures                         (91 )                (547 )              456              2.8pp
Impact of the 53rd week of
shipments in 2011                             (226 )                   -               (226 )          (1.3)pp
Impact of foreign currency                     (91 )                   -                (91 )          (0.5)pp
Sales to Mondel?z International               (100 )                 (79 )              (21 )          (0.1)pp

Organic Net Revenues (1)            $       18,147        $       17,171        $       976               5.7%

Volume/mix                                                                      $      (140 )          (0.8)pp
Net pricing                                                                     $     1,116              6.5pp

(1) Please see the Non-GAAP Financial Measures section at the end of this item.

Organic Net Revenue grew across all segments, driven by higher net pricing, partially offset by unfavorable volume/mix. Higher net pricing was reflected in all segments as we increased pricing to offset higher commodity costs. Unfavorable volume/mix was driven by lower shipments in the Grocery, Cheese, Refrigerated Meals, and International & Foodservice segments, partially offset by higher shipments in the Beverages segment and favorable mix in the International & Foodservice segment. Divestitures (primarily the Starbucks CPG business and the Frozen Pizza business) had an unfavorable impact of $456 million on net revenues. The 53rd week of shipments in 2011 increased net revenues by $226 million. Favorable foreign currency increased net revenues by $91 million, due to the strength of the Canadian dollar relative to the U.S. dollar, and net revenues rose $21 million from higher sales to Mondel?z International.

Operating Income - Operating income decreased $137 million (4.6%) to $2,828 million in 2011, due to the following:

                                                       Operating
                                                        Income                    Change
                                                     (in millions)          (percentage point)

Operating Income for the Year Ended
December 31, 2010                                   $         2,965
Higher net pricing                                            1,116                      40.0pp
Higher product costs                                         (1,013 )                  (36.4)pp
Unfavorable volume/mix                                          (66 )                   (2.3)pp
Lower selling, general and administrative
expenses                                                         68                       2.5pp
Favorable foreign currency                                       16                       0.6pp
Impact of the 53rd week of shipments in 2011                     62                       2.2pp
Change in market-based impacts to
postemployment benefit plans                                    (67 )                   (2.3)pp
Change in unrealized gains/losses on hedging
activities                                                      (92 )                   (3.3)pp
Impact of divestitures                                         (162 )                   (5.6)pp
Other, net                                                        1                           -

Operating Income for the Year Ended
December 31, 2011                                   $         2,828                      (4.6)%

Higher pricing outpaced increased product costs during 2011. The increase in product costs was driven by significantly higher commodity costs, partially offset by lower manufacturing costs as a result of net productivity savings. Unfavorable volume/mix was driven by the Grocery, Cheese, and Refrigerated Meals segments. Selling, general and administrative expenses decreased $68 million from 2010 excluding the impacts of foreign currency, divestitures, and the 53rd week of shipments in 2011. Favorable foreign currency increased operating income by $16 million driven by the strength of the Canadian dollar versus the U.S. dollar. The 53rd week of shipments in 2011 added $62 million in operating income. The change in market-based impacts to postemployment benefit plans decreased operating income by $67 million, as we recorded a mark-to-market expense of $70 million in 2011, versus a mark-to-market expense of $3 million in 2010. The change in unrealized gains/losses on hedging activities decreased operating income by $92 million, as we recognized losses of $64 million in 2011, versus gains of $28 million in 2010. The impact of divestitures (including primarily the Starbucks CPG business cessation and income from a transition services agreement related to the Frozen Pizza business) decreased operating income $162 million.


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Net Earnings and Diluted EPS - Net earnings of $1,775 million decreased by $1,759 million (49.8%) in 2011. Diluted EPS from continuing operations were $3.00 in 2011, down 6.0% from $3.20 in 2010. Diluted EPS were $3.00 in 2011, down 49.8% from $5.98 in 2010, due to the following:

                                                                      Diluted EPS
Diluted EPS for the Year Ended December 31, 2010                      $       5.98
Discontinued operations                                                       2.78

Diluted EPS from Continuing Operations for the Year Ended
December 31, 2010                                                             3.20
Increases in operations                                                       0.14
Change in foreign currency                                                    0.02
Impact of the 53rd week of shipments in 2011                                  0.07
Market-based impacts to postemployment benefit plans                         (0.08 )
Change in unrealized gains/losses on hedging activities                      (0.10 )
Impact of divestitures                                                       (0.20 )
Royalty income from Mondel?z International                                    0.01
Changes in taxes                                                             (0.06 )
. . .
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