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KRFT > SEC Filings for KRFT > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for KRAFT FOODS GROUP, INC.

Form 10-K for KRAFT FOODS GROUP, INC.


21-Feb-2014

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 manufacture and market food and beverage products, including refrigerated meals, refreshment beverages, 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.
We were a wholly owned subsidiary of Mondel?z International until October 1, 2012. On that date, Mondel?z International spun-off Kraft Foods Group, comprising the North American grocery business, to Mondel?z International's shareholders. As a result of the Spin-Off, we now operate as an independent publicly traded company.


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 for the years ended December 29, 2012 and December 31, 2011, included certain expenses of Mondel?z International that were allocated to us. 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.
Cost Savings Initiatives
We incurred cost savings initiatives expenses of $290 million in 2013 and $303 million in 2012. Our costs savings initiatives include a multi-year $650 million restructuring program consisting of restructuring costs, implementation costs, and Spin-Off transition costs (the "Restructuring Program"), which was approved by our Board of Directors on October 29, 2012. We have reduced our estimate of the total Restructuring Program costs to $625 million. Approximately one-half of these costs will be cash expenditures. We spent cash of $150 million in 2013 and $111 million in 2012 related to our Restructuring Program. We expect to complete the Restructuring Program by the end of 2014. 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. On July 18, 2012, Mondel?z International completed a debt exchange in which $3.6 billion of Mondel?z International's debt was exchanged for our debt as part of our Spin-Off-related capitalization plan. There were no cash proceeds from the exchange. On October 1, 2012, Mondel?z International also transferred approximately $0.4 billion of Mondel?z International's 7.550% senior unsecured notes to us to complete the key elements of the capitalization plan in connection with the Spin-Off.
Postemployment Benefit Plans
We remeasure all of our postemployment benefit plans at least annually at the end of our fiscal year. The remeasurement as of December 28, 2013 resulted in an aggregate benefit from market-based impacts of $1.6 billion, primarily driven by an 80 basis point weighted average increase in the discount rate for our pension and postretirement plans and excess asset returns in our pension plans. The annual remeasurement resulted in expense from market-based impacts of $223 million as of December 29, 2012 and $70 million as of December 31, 2011. We disclose market-based impacts separately in order to provide better transparency of our operating results. We define market-based impacts as the costs or benefits resulting from the change in discount rates, the difference between our estimated and actual return on trust assets, and other assumption changes driven by changes in the law or other external factors. 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 contended was a violation and breach of the Starbucks Agreement. The dispute was arbitrated in Chicago, Illinois, and on November 12, 2013, the arbitrator issued a decision awarding us compensation for Starbucks' unilateral termination of the Starbucks Agreement. While we remained the named party in the proceeding, pursuant to the Separation and Distribution Agreement between Mondel?z International and us, Mondel?z International paid any costs and expenses incurred in connection with the arbitration and we directed the payment of the recovery we were awarded in the arbitration proceeding to Mondel?z International. The arbitration's outcome did not have a material financial impact on us. The results of the Starbucks CPG business were included our Beverages and Canada segments through March 1, 2011. Provision for Income Taxes
Our effective tax rate was 33.6% in 2013, 33.1% in 2012, and 38.3% in 2011. Our 2013 effective tax rate was unfavorably impacted by an increase in earnings due to the remeasurements of certain postemployment benefit plans and favorably impacted by net discrete items totaling $61 million primarily from various U.S. federal, foreign,


and state tax audit developments, statute of limitations expirations during the year, and valuation allowance reversals of $23 million.
Our 2012 effective tax rate was favorably impacted by net discrete items totaling $33 million, arising principally from U.S. federal, foreign, and state tax audit developments during the year.
Our 2011 effective tax rate was unfavorably impacted by net discrete items totaling $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. Consolidated Results of Operations
The following discussion compares our consolidated results of operations for 2013 with 2012 and 2011.

Summary of Results
                                              For the Years Ended
                                December 28,       December 29,      December 31,
                                    2013               2012              2011         2013 v. 2012     2012 v. 2011
                                      (in millions, except per share data)
Net revenues                  $       18,218     $       18,271           18,576          (0.3 )%          (1.6 )%
Operating income              $        4,591     $        2,670            2,828          71.9  %          (5.6 )%
Net earnings                  $        2,715     $        1,642            1,775          65.3  %          (7.5 )%
Diluted earnings per share(1) $         4.51     $         2.75             3.00          64.0  %          (8.3 )%

(1) Diluted earnings per share ("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.

Net Revenues
                                      For the Years Ended
                                 December 28,      December 29,
                                     2013              2012        % Change
                                         (in millions)
Net revenues                    $      18,218     $     18,271      (0.3 )%
Impact of foreign currency                 73                -       0.4 pp
Sales to Mondel?z International          (147 )           (114 )    (0.2 )pp
Organic Net Revenues (1)        $      18,144     $     18,157      (0.1 )%
Volume/mix                                                           0.5 pp
Net pricing                                                         (0.6 )pp


                                               For the Years Ended
                                          December 29,      December 31,
                                              2012              2011        % Change
                                                  (in millions)
Net revenues                             $      18,271     $     18,576      (1.6 )%
Impact of divestitures                               -              (91 )     0.4 pp
Impact of 53rd week of shipments in 2011             -             (225 )     1.3 pp
Impact of foreign currency                          21                -       0.1 pp
Sales to Mondel?z International                   (114 )           (100 )    (0.1 )pp
Organic Net Revenues (1)                 $      18,178     $     18,160       0.1  %
Volume/mix                                                                   (2.8 )pp
Net pricing                                                                   2.9 pp

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


2013 compared with 2012:
Organic Net Revenues were flat as lower net pricing was generally offset by favorable volume/mix. Lower net pricing (0.6 pp) was due primarily to increased competitive activity in Beverages and Enhancers & Snack Nuts, partially offset by higher net pricing in Meals & Desserts and Refrigerated Meals. Favorable volume/mix (0.5 pp) was driven primarily by base business growth, despite an unfavorable product line pruning impact of approximately one percentage point. Higher sales to Mondel?z International increased net revenues by $33 million while foreign currency negatively impacted net revenues by $73 million due to the strength of the U.S. dollar relative to the Canadian dollar. 2012 compared with 2011:
Organic Net Revenues were flat as the impact of higher net pricing was generally offset by unfavorable volume/mix. Higher net pricing (2.9 pp), including the impact of pricing from prior periods, was realized across all business segments as we increased pricing to offset higher commodity costs. Unfavorable volume/mix (2.8 pp)reflected lower shipments in all segments except Meals & Desserts (including negative impacts from product line pruning of approximately one percentage point and customer trade inventory reductions). Sales to Mondel?z International increased net revenues by $14 million while unfavorable foreign currency lowered net revenues by $21 million, due to the strength of the U.S. dollar relative to the Canadian dollar. In 2011, net revenues included a 53rd week of shipments that added $225 million to net revenues and divestitures (including the Starbucks CPG business) that contributed $91 million to net revenues.

Operating Income
                                               Operating Income     Operating Income     2013 v. 2012      2012 v. 2011
                                                           (in millions)                       (percentage point)
Operating Income for the Years Ended December
29, 2012 and December 31, 2011                $          2,670     $          2,828
(Lower) / higher net pricing                              (109 )                526           (3.4 )           18.7
Lower / (higher) product costs                              72                  (42 )          2.3             (1.5 )
Favorable / (unfavorable) volume/mix                        40                 (229 )          1.2             (8.1 )
Lower selling, general and administrative
expenses                                                   131                   55            4.1              1.9
Lower / (higher) cost savings initiatives
expenses                                                    13                 (303 )          0.8            (10.5 )
Impact of the 53rd week of shipments in 2011                 -                  (62 )            -             (2.5 )
Change in unrealized gains / (losses) on
hedging activities                                           8                   77            0.2              2.8
Change
in market-based impacts to postemployment
benefit plans                                            1,784                 (153 )         67.2             (5.4 )
Other, net                                                 (18 )                (27 )         (0.5 )           (1.0 )
Operating Income for the Years Ended December
28, 2013 and December 29, 2012                $          4,591     $          2,670           71.9 %           (5.6 )%

2013 compared with 2012:
Lower net pricing was due primarily to increased competitive activity in Beverages and Enhancers & Snack Nuts, partially offset by higher commodity cost-driven pricing in Meals & Desserts and Refrigerated Meals. Lower product costs reflected lower manufacturing costs driven by net productivity, partially offset by higher commodity costs (primarily dairy and meat products). Improved product mix drove favorable volume/mix, partially offset by lower volumes due to product line pruning.
Lower selling, general and administrative expenses reflected lower overhead costs driven by cost management efforts, partially offset by higher marketing spending and the costs of operating as an independent public company (which were not part of our cost profile in the first three quarters of 2012). We incurred $290 million of costs related to our cost savings initiatives in 2013 compared to $303 million in 2012.
The change in unrealized gains / (losses) on hedging activities increased operating income by $8 million, as we recognized gains of $21 million in 2013 versus gains of $13 million in 2012.


The change in market-based impacts to postemployment benefit plans increased operating income by $1,784 million as we recorded income from market-based impacts to our postemployment benefit plans of $1,561 million in 2013 (which consisted of income of $1,635 million from changes in discount rates and excess asset returns, partially offset by expense of $74 million from changes in actuarial assumptions) compared to a net expense of $223 million in 2012 (which consisted of expense of $594 million from changes in actuarial assumptions, partially offset by excess asset returns of $371 million). 2012 compared with 2011:
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 reflected customer trade inventory reductions and the impact of higher pricing. Total selling, general and administrative expenses decreased $55 million in 2012 from 2011, despite an increase in marketing spending. The 53rd week of shipments in 2011 had an unfavorable year-over-year impact on operating income of $62 million.
We recorded expenses related to our costs savings initiatives of $303 million in 2012, compared to none 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 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 expense of $594 million from changes in actuarial assumptions, partially offset by excess asset returns of $371 million), versus a mark-to-market expense of $70 million in 2011. Included in other, net is the impact of divestitures (primarily the Starbucks CPG business cessation) which decreased operating income by $20 million. Net Earnings and Diluted Earnings per Share Net earnings increased 65.3% to $2,715 million in 2013 and decreased by 7.5% to $1,642 million in 2012. Diluted EPS was $4.51 in 2013, up $1.76 from $2.75 in 2012. Diluted EPS was down $0.25 in 2012 from $3.00 in 2011.

                                                               Diluted EPS     Diluted EPS

Diluted EPS for the Years Ended December 29, 2012 and
December 31, 2011                                             $      2.75     $      3.00
Increase in operations                                               0.14            0.33
Change in cost savings initiatives expenses                          0.02           (0.32 )
Impact of the 53rd week of shipments in 2011                            -           (0.07 )
Change in unrealized gains / (losses) on hedging activities          0.01            0.08
Change in market-based impacts to postemployment benefit
plans                                                                1.90           (0.15 )
Higher interest and other expense, net                              (0.27 )         (0.27 )
Royalty income from Mondel?z International                          (0.04 )         (0.01 )
Changes in taxes                                                     0.03            0.21
Other, net                                                          (0.03 )         (0.05 )
Diluted EPS for the Years Ended December 28, 2013 and
December 29, 2012                                             $      4.51     $      2.75

2013 compared with 2012:
In addition to the items impacting operating income, the increase in Diluted EPS in 2013 compared to 2012 was driven by the increase in interest and other expense, net. 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. We incurred a full year of interest and other expense, net in 2013 compared to only a partial year in 2012 related to these debt instruments.


2012 compared with 2011:
In addition to the items impacting operating income, the decrease in Diluted EPS in 2012 compared to 2011 was driven by the increase in interest and other expense, net. 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. As a result, we incurred a partial year of interest and other expense, net in 2012 related to these debt instruments compared to none in 2011. Results of Operations by Reportable Segment Effective July 1, 2013, we began managing and reporting operating results through six reportable segments: Beverages, Cheese, Refrigerated Meals, Meals & Desserts, Enhancers & Snack Nuts, and Canada. Our remaining businesses, including our Foodservice and Exports businesses, are aggregated and disclosed as "Other Businesses". We reflect this reorganization for all the historical periods presented.
The following discussion compares our results of operations for each of our reportable segments for 2013 with 2012 and 2012 with 2011.

                                       For the Years Ended
                        December 28,      December 29,      December 31,
                            2013              2012              2011
                                          (in millions)
Net revenues:
Beverages              $        2,681    $        2,718    $        2,990
Cheese                          3,925             3,829             3,788
Refrigerated Meals              3,334             3,280             3,313
Meals & Desserts                2,305             2,311             2,271
Enhancers & Snack Nuts          2,101             2,220             2,259
Canada                          2,037             2,010             1,967
Other Businesses                1,835             1,903             1,988
Net revenues           $       18,218    $       18,271    $       18,576


                                                                   For the Years Ended
                                                      December 28,     December 29,     December 31,
                                                          2013             2012             2011
                                                                      (in millions)
Earnings before income taxes:
Operating income:
Beverages                                            $        349     $        260     $        450
Cheese                                                        634              618              629
Refrigerated Meals                                            329              379              319
Meals & Desserts                                              665              712              722
Enhancers & Snack Nuts                                        529              592              594
Canada                                                        373              301              302
Other Businesses                                              227              180              182
Unrealized gains / (losses) on hedging activities              21               13              (64 )
Certain postemployment benefit plan income / (costs)        1,622             (305 )           (240 )
General corporate expenses                                   (158 )            (80 )            (66 )
Operating income                                     $      4,591     $      2,670     $      2,828

Management uses segment operating income to evaluate segment performance and allocate resources. We believe it is appropriate to disclose this measure to help investors analyze segment performance and trends. Segment operating income excludes unrealized gains and losses on hedging activities, certain components of our


postemployment benefit plans, and general corporate expenses (which are a component of selling, general and administrative expenses) for all periods presented.
We exclude the unrealized gains and losses on hedging activities (which are a component of cost of sales) from segment operating income in order to provide better transparency of our segment operating results. Once realized, the gains and losses on hedging activities are recorded within segment operating results. We exclude certain components of our postemployment benefit plans (which are a component of cost of sales and selling, general and administrative expenses) from segment operating income because we centrally manage postemployment benefit plan funding decisions and the determination of discount rate, expected rate of return on plan assets, and other actuarial assumptions. We also manage market-based impacts to these benefit plans centrally. Therefore, we allocate only the service cost component of our pension plan expense to segment operating income.
Included within our segment results above are sales to Mondel?z International that totaled $147 million in 2013, $114 million in 2012, and $100 million in 2011. These sales are excluded from Organic Net Revenues.

Beverages
                                 For the Years Ended
                            December 28,       December 29,
                                2013               2012         $ Change     % Change
                                           (in millions)
Net revenues             $     2,681          $       2,718    $     (37 )     (1.4 )%
Organic Net Revenues(1)        2,681                  2,718          (37 )     (1.4 )%
Segment operating income         349                    260           89       34.2  %

                                 For the Years Ended
                            December 29,       December 31,
                                2012               2011         $ Change     % Change
                                           (in millions)
Net revenues             $     2,718          $       2,990    $    (272 )     (9.1 )%
Organic Net Revenues(1)        2,718                  2,866         (148 )     (5.2 )%
Segment operating income         260                    450         (190 )    (42.2 )%

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

2013 compared with 2012:
Net revenues and Organic Net Revenues decreased 1.4%, due to lower net pricing (6.1 pp), partially offset by favorable volume/mix (4.7 pp). Lower net pricing was due primarily to lower commodity cost-driven pricing in coffee, increased promotions in ready-to-drink beverages, and increased competitive activity in liquid concentrates. Favorable volume/mix was driven primarily by growth in new on-demand coffee and liquid concentrate products as well as higher shipments of ready-to-drink beverages, partially offset by lower shipments of powdered beverages.
Segment operating income increased 34.2%, due to lower manufacturing costs driven by net productivity, favorable volume/mix, and lower overhead costs, partially offset by higher marketing spending on new products and unfavorable pricing net of commodity costs.
2012 compared with 2011:
Net revenues decreased 9.1%, which includes the impacts of the Starbucks CPG business cessation (2.7 pp) and the 53rd week of shipments in 2011 (1.2 pp). Organic Net Revenues declined 5.2%, due primarily to unfavorable volume/mix (5.5 pp, including a negative impact from customer trade inventory reductions). Unfavorable volume/mix was driven by lower shipments of ready-to-drink beverages, mainstream coffee, powdered beverages and Tassimo coffee, partially offset by favorable volume/mix from liquid concentrates, driven by new products, and the roll-out of Gevalia coffee.


Segment operating income decreased 42.2%, due primarily to costs incurred for the Restructuring Program, unfavorable volume/mix, unfavorable pricing net of commodity costs, and higher marketing spending. This was partially offset by lower overhead costs.

Cheese
                                 For the Years Ended
                            December 28,       December 29,
                                2013               2012         $ Change    % Change
                                          (in millions)
Net revenues             $     3,925          $       3,829    $    96         2.5  %
Organic Net Revenues(1)        3,874                  3,817         57         1.5  %
Segment operating income         634                    618         16         2.6  %

                                 For the Years Ended
                            December 29,       December 31,
                                2012               2011         $ Change    % Change
                                          (in millions)
Net revenues             $     3,829          $       3,788    $    41         1.1  %
Organic Net Revenues(1)        3,817                  3,742         75         2.0  %

Segment operating income 618 629 (11 ) (1.7 )%

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

2013 compared with 2012:
Net revenues increased 2.5%, which includes the impact of higher sales to Mondel?z International (1.0 pp). Organic Net Revenues increased 1.5%, driven primarily by favorable volume/mix (1.6 pp) as higher shipments of natural cheese and sandwich cheese were partially offset by lower shipments of snacking cheese, due in part to a voluntary string cheese recall.
Segment operating income increased 2.6% as lower marketing spending, lower overhead costs, favorable volume/mix, and lower manufacturing costs driven by . . .

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