<Page>
Exhibit 13
Kraft Foods Inc.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Overview
Kraft Foods Inc. ("Kraft"), together with its subsidiaries (collectively
referred to as the "Company") is the largest branded food and beverage company
headquartered in the United States. Prior to June 13, 2001, the Company was a
wholly-owned subsidiary of Altria Group, Inc. (formerly Philip Morris Companies
Inc.). On June 13, 2001, the Company completed an initial public offering
("IPO") of 280,000,000 shares of its Class A common stock at a price of $31.00
per share. The IPO proceeds, net of the underwriting discount and expenses, of
$8.4 billion were used to retire a portion of an $11.0 billion long-term note
payable to Altria Group, Inc., incurred in connection with the acquisition of
Nabisco Holdings Corp. ("Nabisco"). After the IPO, Altria Group, Inc. owned
approximately 83.9% of the outstanding shares of the Company's capital stock
through its ownership of 49.5% of the Company's Class A common stock and 100% of
the Company's Class B common stock. The Company's Class A common stock has one
vote per share, while the Company's Class B common stock has ten votes per
share. At December 31, 2002, Altria Group, Inc. held 97.8% of the combined
voting power of the Company's outstanding capital stock and owned approximately
84.2% of the outstanding shares of the Company's capital stock.
The Company conducts its global business through two subsidiaries: Kraft Foods
North America, Inc. ("KFNA") and Kraft Foods International, Inc. ("KFI"). KFNA
manages its operations by product category, while KFI manages its operations by
geographic region. KFNA's segments are Cheese, Meals and Enhancers; Biscuits,
Snacks and Confectionery; Beverages, Desserts and Cereals; and Oscar Mayer and
Pizza. KFNA's food service business within the United States and its businesses
in Canada and Mexico are reported through the Cheese, Meals and Enhancers
segment. KFI's segments are Europe, Middle East and Africa; and Latin America
and Asia Pacific.
Critical Accounting Policies
Financial Reporting Release No. 60, which was issued by the Securities and
Exchange Commission ("SEC"), requires all registrants to discuss critical
accounting policies or methods used in the preparation of financial statements.
Note 2 to the consolidated financial statements includes a summary of the
significant accounting policies and methods used in the preparation of the
Company's consolidated financial statements. In most instances, the Company must
use an accounting policy or method because it is the only policy or method
permitted under accounting principles generally accepted in the United States of
America ("U.S. GAAP").
The preparation of all financial statements includes the use of estimates and
assumptions that affect a number of amounts included in the Company's
financial statements, including, among other things, employee benefit costs
and income taxes. The Company bases its estimates historical experience and
other assumptions that it believes are reasonable. If actual amounts are
ultimately different from previous estimates, the revisions are included in
the Company's results for the period in which the actual amounts become
known. Historically, the aggregate differences, if any, between the Company's
estimates and actual amounts in any year have not had a significant impact on
the Company's consolidated financial statements.
The Company's Audit Committee has reviewed the development, selection and
disclosure of the critical accounting policies and estimates.
The following is a review of the more significant assumptions and estimates, as
well as the accounting policies and methods used in the preparation of the
Company's consolidated financial statements:
Employee Benefit Plans: As discussed in Note 14 to the consolidated financial
statements, the Company provides a range of benefits to its employees and
retired employees, including pensions, postretirement health care benefits
and postemployment benefits (primarily severance). The Company records
amounts relating to these plans based on calculations specified by U.S. GAAP,
which include various actuarial assumptions, such as discount rates, assumed
rates of return on plan assets, compensation increases, turnover rates and
health care cost trend rates. The Company reviews its actuarial assumptions
on an annual basis and makes modifications to the assumptions based on
current rates and trends when it is deemed appropriate to do so. As required
by U.S. GAAP, the effect of the modifications is generally recorded or
amortized over future periods. The Company believes that the assumptions
utilized in recording its obligations under its plans, which are presented in
Note 14 to the consolidated financial statements, are reasonable based on its
experience and advice from its actuaries.
During the years ended December 31, 2002, 2001 and 2000, the Company recorded
the following amounts in the consolidated statement of earnings for employee
benefit plans:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
U.S. pension plan income $(33) $(227) $(315)
Non-U.S. pension plan cost 47 35 34
Postretirement healthcare cost 217 199 126
Postemployment benefit plan cost 35 12 9
Employee savings plan cost 64 63 43
- --------------------------------------------------------------------------------
Net expense (income) for employee
benefit plans $330 $ 82 $(103)
================================================================================
</Table>
The 2002 net expense for employee benefit plans of $330 million increased by
$248 million over the 2001 amount. This increase includes the costs associated
with voluntary early retirement and integration programs ($148 million), which
were recorded during 2002. The remainder of the cost increase primarily relates
to a lowering of the Company's discount rate assumption on its pension and
postretirement benefit plans, and lower than expected returns on invested
pension assets. The 2001 net expense for employee benefit plans of $82 million
increased by $185 million over the 2000 amount. This increase was due primarily
to the Company's acquisition of Nabisco, lower pension asset returns and higher
retiree medical costs.
26
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Kraft Foods Inc.
At December 31, 2002, for the U.S. pension and postretirement plans, the Company
reduced its discount rate assumption from 7.0% to 6.5%, maintained its expected
return on asset assumption at 9.0%, and increased its medical trend rate
assumption. The Company presently anticipates that these assumption changes,
coupled with lower returns on pension fund assets in prior years, will result in
an increase in 2003 pre-tax benefit expense of approximately $180 million, or
approximately $0.07 per share, exclusive of the impact of the voluntary early
retirement and integration programs in 2002. The Company's long-term rate of
return assumption remains at 9.0% based on the investment of its pension assets
primarily in U.S. equity securities. While the Company does not presently
anticipate a change in its 2003 assumptions, a fifty basis point decline in
the Company's discount rate would increase the Company's pension and
postretirement expense by approximately $50 million, while a fifty basis point
increase in the discount rate would decrease pension and postretirement expense
by approximately $35 million. Similarly, a fifty basis point decline (increase)
in the expected return on plan assets would increase (decrease) the Company's
pension expense for the U.S. pension plans by approximately $35 million. See
Note 14 to the consolidated financial statements, for a sensitivity discussion
of the assumed health care cost trend rates.
Revenue Recognition: As required by U.S. GAAP, the Company recognizes revenues,
net of sales incentives, and including shipping and handling charges billed to
customers, upon shipment of goods when title and risk of loss pass to customers.
Shipping and handling costs are classified as part of cost of sales. Provisions
and allowances for sales returns and bad debts are also recorded in the
Company's consolidated financial statements. The amounts recorded for these
provisions and related allowances are not significant to the Company's
consolidated financial position or results of operations. As discussed in Note 2
to the consolidated financial statements, effective January 1, 2002, the Company
adopted newly required accounting standards mandating that certain costs
reported as marketing, administration and research costs be shown as a reduction
of operating revenues or an increase in cost of sales. As a result, previously
reported revenues were reduced by approximately $4.6 billion and $3.6 billion
for 2001 and 2000, respectively. The adoption of the new accounting standards
had no impact on operating income, net earnings or basic or diluted earnings per
share ("EPS").
Depreciation and Amortization: The Company depreciates property, plant and
equipment and amortizes definite life intangibles using straight-line methods
over the estimated useful lives of the assets. As discussed in Note 2 to the
consolidated financial statements, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No.
142, "Goodwill and Other Intangible Assets," on January 1, 2002. The Company
has determined that substantially all of its goodwill and other intangible
assets have indefinite lives due to the long history of its brands. As a
result, the Company stopped recording the amortization of goodwill and
substantially all of its intangible assets as a charge to earnings. Net
earnings and diluted EPS would have been as follows had the provisions of the
new standards been applied as of January 1, 2000:
<Table>
<Caption>
(in millions, except per share amounts)
- --------------------------------------------------------------------------------
Year Ended December 31, 2001 2000
- --------------------------------------------------------------------------------
Net earnings, as previously reported $1,882 $2,001
Adjustment for amortization
of goodwill and indefinite
life intangibles 955 530
- --------------------------------------------------------------------------------
Net earnings, as adjusted $2,837 $2,531
================================================================================
Diluted EPS, as previously reported $ 1.17 $ 1.38
Adjustment for amortization
of goodwill and indefinite
life intangibles 0.59 0.36
- --------------------------------------------------------------------------------
Diluted EPS, as adjusted $ 1.76 $ 1.74
- --------------------------------------------------------------------------------
Average diluted shares outstanding 1,610 1,455
- --------------------------------------------------------------------------------
</Table>
Marketing and Advertising Costs: As required by U.S. GAAP, the Company records
marketing costs as an expense in the year to which such costs relate. The
Company does not defer any amounts on its consolidated balance sheet with
respect to marketing costs. The Company expenses advertising costs in the year
in which the related advertisement initially appears. The Company records
consumer incentive and trade promotion costs as a reduction of revenues in the
year in which these programs are offered, based on estimates of utilization and
redemption rates that are developed from historical information.
Related Party Transactions: As discussed in Note 3 to the consolidated financial
statements, Altria Group, Inc.'s subsidiary, Altria Corporate Services, Inc.
(formerly Philip Morris Management Corp.), provides the Company with various
services, including planning, legal, treasury, accounting, auditing, insurance,
human resources, office of the secretary, corporate affairs, information
technology and tax services. Billings for these services, which were based on
the cost to Altria Corporate Services, Inc. to provide such services plus a
management fee, were $327 million, $339 million and $248 million for the years
ended December 31, 2002, 2001 and 2000, respectively. Although the value of
services provided by Altria Corporate Services, Inc. cannot be quantified on a
stand-alone basis, management believes that the billings are reasonable based on
the level of support provided by Altria Corporate Services, Inc., and that the
charges reflect all services provided. The cost and nature of the services are
reviewed annually by the Company's Audit Committee, which is comprised of
independent directors.
The Company also has long-term notes payable to Altria Group, Inc. and its
affiliates of $2.6 billion at December 31, 2002 and $5.0 billion at December
31, 2001. The decrease from 2001 to 2002 reflects the repayment of borrowings
with proceeds from public global bond offerings, floating rate notes and
short-term borrowings. The interest rates on the debt with Altria Group, Inc.
were established at market rates available to Altria Group, Inc. at the time
of issuance for similar debt with matching maturities. The remaining amount
due under the 7.0% long-term note payable to Altria Group, Inc. and
affiliates has no prepayment penalty, and
27
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Kraft Foods Inc.
the Company may repay some or all of the note with the proceeds from external
debt offerings.
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." The accounts of the Company are included in the
consolidated federal income tax return of Altria Group, Inc. Income taxes are
generally computed on a separate company basis. To the extent that foreign tax
credits, capital losses and other credits generated by the Company, which cannot
be utilized on a separate company basis, are utilized in Altria Group, Inc.'s
consolidated federal income tax return, the benefit is recognized in the
calculation of the Company's provision for income taxes. The Company utilized
tax benefits that it would otherwise not have been able to use of $193 million,
$185 million and $139 million for the years ended December 31, 2002, 2001 and
2000, respectively.
Business Environment
The Company faces a number of challenges in 2003, including among other
things, higher benefit costs, increased stock compensation costs and weak
economies in certain parts of Latin America. As previously discussed, higher
benefit costs are expected to impact 2003 EPS by approximately $0.07 per
share. The higher benefit costs are primarily the result of lower returns on
pension fund assets, a lower discount rate and higher retiree medical costs.
The additional stock compensation costs, which are expected to impact 2003
earnings per share by approximately $0.02 per share, relate to restricted
stock awards to employees. These awards have a three-year vesting period and
will further align the long-term interests of employees with those of the
Company's shareholders. The award of restricted stock to employees (rather
than stock options) is more transparent to shareholders as the cost of the
program is based upon the average market price of the stock on the date of
grant, rather than a fair value generated by an option-pricing model. In
Latin America, political unrest in Venezuela, as well as the devaluation of
certain currencies, are also expected to negatively impact 2003 EPS.
The Company is subject to fluctuating commodity costs, currency movements and
competitive challenges in various product categories and markets, including a
trend toward increasing consolidation in the retail trade and consequent
inventory reductions and changing consumer preferences. In addition, certain
competitors may have different profit objectives, and some competitors may be
more or less susceptible to currency exchange rates. To confront these
challenges, the Company continues to take steps to build the value of its brands
and improve its food business portfolio with new products and marketing
initiatives.
Fluctuations in commodity costs can lead to retail price volatility,
intensify price competition and influence consumer and trade buying patterns.
KFNA's and KFI's businesses are subject to fluctuating commodity costs,
including dairy, coffee bean and cocoa costs. Dairy commodity costs on average
were lower in 2002 than those seen in 2001. Coffee bean prices were also
lower, while cocoa bean prices were higher than in 2001.
On December 11, 2000, the Company acquired all of the outstanding shares of
Nabisco for $55 per share in cash. The purchase of the outstanding shares,
retirement of employee stock options and other payments totaled approximately
$15.2 billion. In addition, the acquisition included the assumption of
approximately $4.0 billion of existing Nabisco debt. The Company financed the
acquisition through the issuance of two long-term notes payable to Altria
Group, Inc., totaling $15.0 billion, and short-term intercompany borrowings
of $255 million. The acquisition has been accounted for as a purchase.
Beginning January 1, 2001, Nabisco's earnings have been included in the
consolidated operating results of the Company.
The closure of a number of Nabisco domestic and international facilities
resulted in severance and other exit costs of $379 million, which are
included in the adjustments for the allocation of the Nabisco purchase price.
The closures will result in the termination of approximately 7,500 employees
and will require total cash payments of $373 million, of which approximately
$190 million has been spent through December 31, 2002. Substantially all of
the closures were completed as of December 31, 2002, and the remaining
payments relate to salary continuation payments for severed employees and
lease payments.
The integration of Nabisco into the operations of the Company has also
resulted in the closure or reconfiguration of several of the Company's
existing facilities. The aggregate charges to the Company's consolidated
statement of earnings to close or reconfigure its facilities and integrate
Nabisco were originally estimated to be in the range of $200 million to $300
million. During 2002, the Company recorded pre-tax integration related
charges of $115 million to consolidate production lines, close facilities and
for other consolidation programs. In addition, during 2001, the Company
incurred pre-tax integration costs of $53 million for site reconfigurations
and other consolidation programs in the United States. The integration
related charges of $168 million included $27 million relating to severance,
$117 million relating to asset write-offs and $24 million relating to other
cash exit costs. Cash payments relating to these charges will approximate $51
million, of which $21 million has been paid through December 31, 2002. In
addition, during 2002, approximately 700 salaried employees elected to retire
or terminate employment under voluntary retirement programs. As a result, the
Company recorded a pre-tax charge of $142 million related to these programs.
As of December 31, 2002, the aggregate pre-tax charges to close or
reconfigure the Company's facilities and integrate Nabisco, including charges
for early retirement programs, were $310 million, slightly above the original
estimate. No additional pre-tax charges are expected to be recorded for these
programs.
During 2001, certain small Nabisco businesses were reclassified to businesses
held for sale, including their estimated results of operations through
anticipated sale dates. These businesses have subsequently been sold, with
the exception of one business that had been held for sale since the
acquisition of Nabisco. This business, which is no longer held for sale, has
been included in 2002 consolidated operating results.
28
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Kraft Foods Inc.
During 2002, the Company acquired a snacks business in Turkey and a biscuits
business in Australia. The total cost of these and other smaller acquisitions
was $122 million. During 2001, the Company purchased coffee businesses in
Romania, Morocco and Bulgaria and also acquired confectionery businesses in
Russia and Poland. The total cost of these and other smaller acquisitions was
$194 million. During 2000, the Company purchased Balance Bar Co. and Boca
Burger, Inc. The total cost of these and other smaller acquisitions was $365
million. The operating results of these businesses were not material to the
Company's consolidated financial position or results of operations in any of the
periods presented.
During 2002, the Company sold several small North American food businesses, some
of which were previously classified as businesses held for sale. The net
revenues and operating results of the businesses held for sale, which were not
significant, were excluded from the Company's consolidated statements of
earnings, and no gain or loss was recognized on these sales. In addition, the
Company sold its Latin American yeast and industrial bakery ingredients business
for $110 million and recorded a pre-tax gain of $69 million. The aggregate
proceeds received from sales of businesses during 2002 were $219 million, on
which the Company recorded pre-tax gains of $80 million.
During 2001, the Company sold several small food businesses. The aggregate
proceeds received in these transactions were $21 million, on which the Company
recorded pre-tax gains of $8 million.
During 2000, the Company sold a French confectionery business for proceeds of
$251 million, on which a pre-tax gain of $139 million was recorded. Several
small international and North American food businesses were also sold in
2000. The aggregate proceeds received from sales of businesses during 2000
were $300 million, on which the Company recorded pre-tax gains of $172
million.
The operating results of the businesses sold were not material to the Company's
consolidated operating results in any of the periods presented.
Century Date Change: The Company did not experience any material disruptions
to its business as a result of the Century Date Change ("CDC"). The Company's
increases in 1999 year-end inventories and trade receivables caused by
preemptive CDC contingency plans resulted in incremental cash outflows during
1999 of approximately $155 million. The cash outflows reversed in the first
quarter of 2000. In addition, the Company had increased shipments in the
fourth quarter of 1999 because customers purchased additional product in
anticipation of potential CDC-related disruptions. The increased shipments in
1999 resulted in estimated incremental net revenues and operating companies
income in 1999 of approximately $85 million and $40 million, respectively,
and corresponding decreases in net revenues and operating companies income in
2000.
53rd Week: The Company's subsidiaries end their fiscal years as of the Saturday
closest to the end of each year. Accordingly, most years contain 52 weeks of
operating results while every fifth or sixth year includes 53 weeks. The
Company's consolidated statement of earnings for the year ended December 31,
2000 included a 53rd week. Volume comparisons contained in this Management's
Discussion and Analysis for 2001 versus 2000 have been provided on a comparable
52-week basis to provide a more meaningful comparison of operating results.
Consolidated Operating Results
The acquisition of Nabisco and subsequent IPO were significant events that
affect the comparability of earnings. In order to isolate the financial
effects of these events, and to provide a more meaningful comparison of the
Company's results of operations, the following tables and the subsequent
discussion of the Company's consolidated operating results refer to results
on a reported and pro forma basis. Reported results include the operating
results of Nabisco in 2002 and 2001, but not in 2000. Reported results also
reflect average shares of common stock outstanding during 2002 and 2001, and
reflect an average of 1.455 billion shares outstanding during 2000. Pro forma
results assume the Company owned Nabisco for all of 2000. In addition, pro
forma results reflect common shares outstanding based on the assumption that
shares issued immediately following the IPO were outstanding during 2001 and
2000, and that, effective January 1, 2000, the net proceeds of the IPO were
used to retire a portion of a long-term note payable used to finance the
Nabisco acquisition. Pro forma results also adjust for other items, all of
which are detailed in reconciliations of reported to pro forma results
throughout this discussion. Management uses pro forma results to manage and
to evaluate the performance of the Company. Management believes it is
appropriate to disclose pro forma results to assist investors with analyzing
business performance and trends. Pro forma measures should not be considered
in isolation or as a substitute for reported results, which are prepared in
accordance with accounting principles generally accepted in the United States.
29
<Page>
Kraft Foods Inc.
<Table>
<Caption>
Consolidated Operating Results
(in millions)
- --------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Reported volume (in pounds):
Kraft Foods North America
Cheese, Meals and Enhancers 5,898 5,219 4,820
Biscuits, Snacks and Confectionery 2,369 2,350 54
Beverages, Desserts and Cereals 3,708 3,421 3,117
Oscar Mayer and Pizza 1,554 1,519 1,507
- --------------------------------------------------------------------------------
Total Kraft Foods North America 13,529 12,509 9,498
- --------------------------------------------------------------------------------
Kraft Foods International
Europe, Middle East and Africa 2,961 2,826 2,829
Latin America and Asia Pacific 2,059 2,057 803
- --------------------------------------------------------------------------------
Total Kraft Foods International 5,020 4,883 3,632
- --------------------------------------------------------------------------------
Total reported volume 18,549 17,392 13,130
- --------------------------------------------------------------------------------
Reported net revenues:
Kraft Foods North America
Cheese, Meals and Enhancers $ 8,877 $ 8,732 $ 7,923
Biscuits, Snacks and Confectionery 5,182 5,071 293
Beverages, Desserts and Cereals 4,412 4,237 4,267
Oscar Mayer and Pizza 3,014 2,930 2,829
- --------------------------------------------------------------------------------
Total Kraft Foods North America 21,485 20,970 15,312
- --------------------------------------------------------------------------------
Kraft Foods International
Europe, Middle East and Africa 6,203 5,936 6,398
Latin America and Asia Pacific 2,035 2,328 1,212
- --------------------------------------------------------------------------------
Total Kraft Foods International 8,238 8,264 7,610
- --------------------------------------------------------------------------------
Total reported net revenues $29,723 $29,234 $22,922
================================================================================
Reported operating
companies income:
Kraft Foods North America
Cheese, Meals and Enhancers $ 2,168 $ 2,099 $ 1,845
Biscuits, Snacks and Confectionery 1,093 966 100
Beverages, Desserts and Cereals 1,136 1,192 1,090
Oscar Mayer and Pizza 556 539 512
- --------------------------------------------------------------------------------
Total Kraft Foods North America 4,953 4,796 3,547
- --------------------------------------------------------------------------------
Kraft Foods International
Europe, Middle East and Africa 962 861 1,019
Latin America and Asia Pacific 368 378 189
- --------------------------------------------------------------------------------
Total Kraft Foods International 1,330 1,239 1,208
- --------------------------------------------------------------------------------
Total reported operating
companies income $ 6,283 $ 6,035 $ 4,755
================================================================================
</Table>
The following is a reconciliation of reported operating results to pro forma
operating results:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Reported volume (in pounds) 18,549 17,392 13,130
Volume of businesses sold (150) (187) (82)
Changes due to businesses
held for sale 647
Estimated impact of century
date change 55
Nabisco volume 4,367
- --------------------------------------------------------------------------------
Pro forma volume (in pounds) 18,399 17,852 17,470
- --------------------------------------------------------------------------------
Reported net revenues $29,723 $29,234 $22,922
Net revenues of businesses sold (89) (121) (162)
Changes due to businesses
held for sale 252
Estimated impact of century
date change 85
Nabisco net revenues 6,822
- --------------------------------------------------------------------------------
Pro forma net revenues $29,634 $29,365 $29,667
================================================================================
Reported operating
companies income $ 6,283 $ 6,035 $ 4,755
Gains on sales of businesses (80) (8) (172)
Operating companies income of
businesses sold (15) (24) (39)
Integration costs and a loss on
sale of a food factory 111 82
Separation programs 142
Changes due to businesses
held for sale 23
Estimated impact of century
date change 40
Nabisco operating
companies income 1,000
- --------------------------------------------------------------------------------
Pro forma operating
companies income $ 6,441 $ 6,108 $ 5,584
================================================================================
Reported net earnings $ 3,394 $ 1,882 $ 2,001
After-tax effect of:
Integration costs and a loss
on sale of a food factory 72 45
Separation programs 91
Gains on sales of businesses (52) (5) (101)
Cessation of goodwill and
indefinite life intangible
asset amortization 955 530
Nabisco results (135)
Interest reduction assuming
full-year IPO 165 363
Estimated impact of century
date change 23
- --------------------------------------------------------------------------------
Pro forma net earnings $ 3,505 $ 3,042 $ 2,681
================================================================================
Average diluted shares outstanding 1,736 1,610 1,455
Adjustment to reflect shares
outstanding after IPO 125 280
- --------------------------------------------------------------------------------
Pro forma diluted shares outstanding 1,736 1,735 1,735
- --------------------------------------------------------------------------------
</Table>
30
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Kraft Foods Inc.
2002 compared with 2001
Reported volume for 2002 increased 1,157 million pounds (6.7%) over 2001, due
primarily to the inclusion in 2002 of a business previously considered held for
sale, new product introductions, geographic expansion and acquisitions. Pro
forma volume increased 3.1% over 2001, due primarily to new product
introductions, geographic expansion and acquisitions.
Reported net revenues for 2002 increased $489 million (1.7%) over 2001, due
primarily to the inclusion in 2002 of a business previously considered held
for sale, higher volume/mix and the impact of acquisitions, partially offset
by the adverse effect of currency exchange rates and lower sales prices on
cheese and coffee products (driven by commodity-related declines). Pro forma
net revenues increased $269 million (0.9%) over 2001, due primarily to higher
volume/mix ($401 million) and the impact of acquisitions ($191 million),
partially offset by the adverse effect of currency exchange rates ($291
million) and lower sales prices on cheese and coffee products (driven by
commodity-related declines).
The Company's management reviews operating companies income to evaluate segment
performance and allocate resources. Operating companies income excludes general
corporate expenses and amortization of intangibles. Reported operating companies
income was affected by the following unusual items during 2002 and 2001:
o Integration Costs and a Loss on Sale of a Food Factory: During 2002, the
Company recorded pre-tax integration related charges of $115 million to
consolidate production lines, close facilities and for other consolidation
programs. In addition, during 2002, the Company reversed $4 million related to
the loss on sale of a North American food factory. During 2001, the Company
incurred pre-tax integration costs of $53 million for site reconfigurations and
other consolidation programs in the United States. In addition, the Company
recorded a pre-tax charge of $29 million to close a North American food factory.
These items were included in the operating companies income of the following
segments:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------
Cheese, Meals and Enhancers $ 30 $63
Biscuits, Snacks and Confectionery 1 2
Beverages, Desserts and Cereals 56 12
Oscar Mayer and Pizza 7 5
Latin America and Asia Pacific 17
- --------------------------------------------------------------------------------
$111 $82
================================================================================
</Table>
o Separation Programs: During 2002, approximately 700 salaried employees
elected to retire or terminate employment under voluntary retirement
programs. As a result, the Company recorded a pre-tax charge in 2002 of $142
million related to these programs. This charge was included in the operating
companies income of the following segments: Cheese, Meals and Enhancers, $60
million; Biscuits, Snacks and Confectionery, $3 million; Beverages, Desserts
and Cereals, $47 million; Oscar Mayer and Pizza, $25 million; Europe, Middle
East and Africa, $5 million; and Latin America and Asia Pacific, $2 million.
o Businesses Held for Sale: During 2001, certain small Nabisco businesses
were reclassified to businesses held for sale, including their estimated
results of operations through anticipated sale dates. These businesses have
subsequently been sold with the exception of one business that had been held
for sale since the acquisition of Nabisco. This business, which is no longer
held for sale, has been included in 2002 reported operating results and has
been included as an adjustment to arrive at pro forma results for 2001.
Reported operating companies income increased $248 million (4.1%) over 2001. On
a pro forma basis, operating companies income increased $333 million (5.5%),
driven primarily by volume growth and favorable margins.
In addition, reported net earnings were also affected by the following during
2002:
o Amortization of Intangibles: On January 1, 2002, the Company adopted SFAS
No. 141 and SFAS No. 142. As a result, the Company stopped recording the
amortization of goodwill and indefinite life intangible assets as a charge to
earnings. Reported net earnings and diluted EPS would have been approximately
$2.8 billion and $1.76, respectively, for the year ended December 31, 2001,
and $2.5 billion and $1.74, respectively, for the year ended December 31,
2000, had the provisions of the new standards been applied in those periods.
Currency movements have decreased net revenues by $291 million and operating
companies income by $4 million from 2001. Decreases in net revenues and
operating companies income are due primarily to the strength of the U.S.
dollar against certain Latin American currencies, partially offset by the
weakness of the U.S. dollar against the euro and other currencies.
Reported interest and other debt expense, net, decreased $590 million in 2002.
This decrease was due primarily to lower debt levels after the repayment of
Nabisco acquisition borrowings with the proceeds from the Company's IPO, as well
as the Company's refinancing of notes payable to Altria Group, Inc. and lower
short-term interest rates. On a pro forma basis, interest and other debt
expense, net, decreased $288 million in 2002 from $1,135 million in 2001. This
decrease in pro forma interest expense is due to the use of free cash flow to
repay debt, the refinancing of notes payable to Altria Group, Inc. and lower
short-term interest rates.
During 2002, the Company's reported effective tax rate decreased by 9.9
percentage points to 35.5% as compared with 2001, due primarily to the adoption
of SFAS No. 141 and SFAS No. 142, under which the Company is no longer required
to amortize goodwill and indefinite life intangible assets as a charge to
earnings.
Reported diluted and basic EPS, which were both $1.96 for 2002, increased by
67.5% over 2001, due primarily to growth in operating companies income, lower
interest expense and the
31
<Page>
Kraft Foods Inc.
elimination of substantially all goodwill amortization. Reported net earnings of
$3,394 million for 2002 increased $1,512 million (80.3%) over 2001. On a pro
forma basis, diluted and basic EPS, which were both $2.02 for 2002, increased by
15.4% over 2001, due primarily to growth in operating companies income and
lower interest expense. On a pro forma basis, net earnings of $3,505 million for
2002 increased $463 million (15.2%) over 2001.
2001 compared with 2000
Reported volume for 2001 increased 4,262 million pounds (32.5%) over 2000, due
primarily to the acquisition of Nabisco. Pro forma volume increased 2.2% over
2000. Excluding the 53rd week of shipments in 2000, volume increased 3.4%,
reflecting new product introductions and volume gains in developing markets.
Reported net revenues for 2001 increased $6,312 million (27.5%) over 2000, due
primarily to the acquisition of Nabisco. Pro forma net revenues decreased
slightly from 2000, due primarily to the 53rd week of sales in 2000, the adverse
effect of currency exchange rates and lower sales prices on coffee products
(driven by commodity-related price declines), partially offset by the favorable
impact of volume growth.
Reported operating companies income increased $1,280 million (26.9%) over 2000,
due primarily to the acquisition of Nabisco. On a pro forma basis, operating
companies income increased $524 million (9.4%), driven by volume growth,
productivity savings and Nabisco synergies, partially offset by unfavorable
currency movements.
Currency movements decreased net revenues by $493 million and operating
companies income by $60 million from 2000. Decreases in net revenues and
operating companies income were due to the strength of the U.S. dollar against
the euro, Canadian dollar and certain Asian and Latin American currencies.
Reported interest and other debt expense, net, increased $840 million in 2001.
This increase was due primarily to notes issued to Altria Group, Inc. in the
fourth quarter of 2000 to finance the acquisition of Nabisco. On a pro forma
basis, interest and other debt expense, net, decreased $213 million in 2001 from
$1,348 million in 2000. This decrease in pro forma interest expense is due to
the use of free cash flow to repay debt and the refinancing of debt payable to
Altria Group, Inc.
During 2001, the Company's reported effective tax rate increased by 4.0
percentage points to 45.4% as compared with 2000, due primarily to higher
Nabisco-related goodwill amortization, which was not tax deductible.
Reported diluted and basic EPS, which were both $1.17 for 2001, decreased by
15.2% from 2000, due primarily to higher levels of goodwill amortization and
interest expense associated with the acquisition of Nabisco. Reported net
earnings of $1,882 million for 2001 decreased $119 million (5.9%) from 2000.
On a pro forma basis, diluted and basic EPS, which were both $1.75 for 2001,
increased by 12.9% over 2000, due primarily to higher operating results in
all segments. On a pro forma basis, net earnings $3,042 million for 2001
increased $361 million (13.5%) from 2000.
Operating Results By Reportable Segment
Kraft Foods North America
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Reported volume (in pounds):
Cheese, Meals and Enhancers 5,898 5,219 4,820
Biscuits, Snacks and Confectionery 2,369 2,350 54
Beverages, Desserts and Cereals 3,708 3,421 3,117
Oscar Mayer and Pizza 1,554 1,519 1,507
- --------------------------------------------------------------------------------
Total reported volume (in pounds) 13,529 12,509 9,498
Volume of businesses sold:
Cheese, Meals and Enhancers (5)
Biscuits, Snacks and Confectionery (15) (13)
Beverages, Desserts and Cereals (1)
Changes due to businesses
held for sale:
Cheese, Meals and Enhancers 647
Estimated impact of century
date change:
Cheese, Meals and Enhancers 16
Biscuits, Snacks and Confectionery 1
Beverages, Desserts and Cereals 19
Oscar Mayer and Pizza 5
Nabisco volume:
Cheese, Meals and Enhancers 1,101
Biscuits, Snacks and Confectionery 2,246
Beverages, Desserts and Cereals 40
- --------------------------------------------------------------------------------
Pro forma volume (in pounds) 13,514 13,142 12,921
- --------------------------------------------------------------------------------
Reported net revenues:
Cheese, Meals and Enhancers $ 8,877 $ 8,732 $ 7,923
Biscuits, Snacks and Confectionery 5,182 5,071 293
Beverages, Desserts and Cereals 4,412 4,237 4,267
Oscar Mayer and Pizza 3,014 2,930 2,829
- --------------------------------------------------------------------------------
Total reported net revenues 21,485 20,970 15,312
Net revenues of businesses sold:
Cheese, Meals and Enhancers (10)
Biscuits, Snacks and Confectionery (21) (19)
Beverages, Desserts and Cereals (12)
Changes due to businesses
held for sale:
Cheese, Meals and Enhancers 252
Estimated impact of century
date change:
Cheese, Meals and Enhancers 29
Biscuits, Snacks and Confectionery 3
Beverages, Desserts and Cereals 16
Oscar Mayer and Pizza 11
Nabisco net revenues:
Cheese, Meals and Enhancers 1,016
Biscuits, Snacks and Confectionery 4,653
Beverages, Desserts and Cereals 79
- --------------------------------------------------------------------------------
Pro forma net revenues $21,464 $21,191 $21,109
================================================================================
</Table>
32
<Page>
Kraft Foods Inc.
Kraft Foods North America (continued)
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Reported Operating
Companies Income:
Cheese, Meals and Enhancers $2,168 $2,099 $1,845
Biscuits, Snacks and Confectionery 1,093 966 100
Beverages, Desserts and Cereals 1,136 1,192 1,090
Oscar Mayer and Pizza 556 539 512
- --------------------------------------------------------------------------------
Total reported operating
companies income 4,953 4,796 3,547
Gains on sales of businesses:
Cheese, Meals and Enhancers (33)
Biscuits, Snacks and Confectionery (8)
Operating companies income of
businesses sold:
Cheese, Meals and Enhancers (4)
Biscuits, Snacks and Confectionery (5) (4)
Beverages, Desserts and Cereals (2)
Integration costs and a loss on
sale of a food factory:
Cheese, Meals and Enhancers 30 63
Biscuits, Snacks and Confectionery 1 2
Beverages, Desserts and Cereals 56 12
Oscar Mayer and Pizza 7 5
Separation programs:
Cheese, Meals and Enhancers 60
Biscuits, Snacks and Confectionery 3
Beverages, Desserts and Cereals 47
Oscar Mayer and Pizza 25
Changes due to businesses
held for sale:
Cheese, Meals and Enhancers 23
Estimated impact of century
date change:
Cheese, Meals and Enhancers 15
Biscuits, Snacks and Confectionery 1
Beverages, Desserts and Cereals 7
Oscar Mayer and Pizza 4
Nabisco operating
companies income:
Cheese, Meals and Enhancers 230
Biscuits, Snacks and Confectionery 671
Beverages, Desserts and Cereals 28
- --------------------------------------------------------------------------------
Pro forma operating
companies income $5,169 $4,895 $4,466
================================================================================
</Table>
2002 compared with 2001
KFNA's reported volume for 2002 increased 8.2% over 2001, due primarily to the
inclusion in 2002 of a business that was previously held for sale and
contributions from new products. On a pro forma basis, volume for 2002 increased
2.8%, due primarily to higher shipments across all segments, which benefited
from contributions by new products.
Reported net revenues increased $515 million (2.5%) over 2001, due primarily to
higher volume/mix ($437 million) and the inclusion in 2002 of a business that
was previously held for sale ($252 million), partially offset by lower selling
prices in response to lower commodity costs ($154 million). On a pro forma
basis, net revenues increased 1.3%.
Reported operating companies income for 2002 increased $157 million (3.3%) over
2001, due primarily to higher volume/mix ($174 million), favorable margins ($176
million, driven by lower commodity-related costs and productivity) and Nabisco
synergy savings, partially offset by higher benefit expense, including the 2002
charge for voluntary retirement programs ($135 million). On a pro forma basis,
operating companies income increased 5.6%.
The following discusses operating results within each of KFNA's reportable
segments.
Cheese, Meals and Enhancers: Reported volume in 2002 increased 13.0% over 2001,
due primarily to the inclusion in 2002 of a business that was previously held
for sale. On a pro forma basis, volume in 2002 increased 0.5%, driven by volume
gains in enhancers, meals and food service, partially offset by a decline in
cheese. Volume gains in enhancers and meals were led by Kraft pourable
dressings, barbecue sauce, macaroni & cheese dinners and the 2001 acquisition of
It's Pasta Anytime. In cheese, volume declined as lower dairy costs resulted in
aggressive competitive activity by private label manufacturers as they reduced
prices and increased merchandising levels.
During 2002, reported net revenues increased $145 million (1.7%) over 2001, due
primarily to the inclusion in 2002 of a business that was previously held for
sale ($252 million) and higher volume/mix ($36 million), partially offset by
lower net pricing ($135 million, primarily related to lower dairy commodity
costs). On a pro forma basis, net revenues decreased 1.2% from the comparable
period of 2001, as lower net pricing was partially offset by higher volume/mix.
Reported operating companies income for 2002 increased $69 million (3.3%) over
2001, due primarily to favorable margins ($48 million, due primarily to lower
cheese commodity costs and productivity savings), higher volume/mix ($30
million), lower integration related costs in 2002 ($33 million) and the
inclusion in 2002 of a business that was previously held for sale ($23 million),
partially offset by higher benefit expenses, including the 2002 charge for
voluntary retirement programs ($60 million). On a pro forma basis, operating
companies income also increased 3.3%, driven by favorable margins and higher
volume/mix, partially offset by higher benefit expenses.
Biscuits, Snacks and Confectionery: Reported volume in 2002 increased 0.8% over
2001. On a pro forma basis, volume in 2002 increased 0.7% over 2001, as volume
gains in biscuits and snacks were partially offset by a decline in confectionery
shipments. In biscuits, volume also increased, due primarily to promotional
initiatives. Confectionery volume declined, resulting primarily from competitive
activity in the breath freshening category, partially offset by new product
introductions in the non-chocolate confectionery business.
33
<Page>
Kraft Foods Inc.
During 2002, reported net revenues increased $111 million (2.2%) over 2001, due
to higher volume/mix ($59 million) and higher net pricing ($52 million). On a
pro forma basis, net revenues also increased 2.2%.
Reported operating companies income for 2002 increased $127 million (13.1%) over
2001, due primarily to favorable margins ($96 million, due primarily to higher
net pricing and lower commodity costs for nuts), Nabisco synergy savings and
higher volume/mix. On a pro forma basis, operating companies income increased
12.4%.
Beverages, Desserts and Cereals: Reported and pro forma volume in 2002 increased
8.4% over 2001, due primarily to growth in ready-to-drink beverages. In coffee,
volume increased, driven by merchandising programs and packaging innovation. In
the desserts business, volume increases were led by dry packaged desserts and
frozen toppings, which benefited from holiday programs, and in ready-to-eat
desserts, aided by new products.
During 2002, reported net revenues increased $175 million (4.1%) over 2001,
due primarily to higher volume/mix ($245 million), partially offset by lower
net pricing ($58 million). On a pro forma basis, net revenues increased 4.4%.
Reported operating companies income for 2002 decreased $56 million (4.7%)
from 2001, primarily reflecting the 2002 charge for voluntary retirement
programs ($47 million), higher integration related costs in 2002 ($44
million), higher marketing, administration and research costs ($36 million,
including higher benefit costs) and lower margins ($18 million), partially
offset by higher volume/mix ($98 million) and productivity savings. On a pro
forma basis, operating companies income increased 3.1%, resulting from volume
growth and productivity savings, partially offset by higher marketing,
administration and research costs.
Oscar Mayer and Pizza: Reported and pro forma volume in 2002 increased 2.3% over
2001, due to volume gains in processed meats and pizza. The increase in
processed meats was driven by gains in hot dogs, bacon and soy-based meat
alternatives, aided by new product introductions. The pizza business also
benefited from new products.
During 2002, reported and pro forma net revenues increased $84 million (2.9%)
over 2001, due to higher volume/mix ($97 million), partially offset by lower net
pricing ($13 million).
Reported operating companies income for 2002 increased $17 million (3.2%) over
2001, primarily reflecting favorable costs ($50 million, due primarily to lower
meat and cheese commodity costs and productivity savings) and higher volume/mix
($30 million), partially offset by the 2002 charge for voluntary retirement
programs ($25 million), higher marketing, administration and research costs ($24
million, including higher benefit costs) and higher manufacturing costs. On a
pro forma basis, operating companies income increase 8.1%.
2001 compared with 2000
KFNA's reported volume for 2001 increased 31.7% over 2000, due primarily to the
acquisition of Nabisco. On a pro forma basis, volume for 2001 increased 1.7%, or
2.9% excluding the 53rd week of shipments in 2000. The 2.9% increase was due
primarily to higher shipments across all segments and reflects contributions
from new products.
Reported net revenues increased $5.7 billion (37.0%) over 2000, due primarily to
the acquisition of Nabisco ($5.7 billion) and the shift in CDC revenues ($59
million), partially offset by unfavorable currency movements ($62 million). On a
pro forma basis, net revenues increased 0.4%, due primarily to higher net
revenues from the Biscuits, Snacks and Confectionery segment and the Oscar Mayer
and Pizza segment, partially offset by the impact of the 53rd week in 2000.
Reported operating companies income for 2001 increased $1,249 million (35.2%)
over 2000, due primarily to the acquisition of Nabisco ($1.2 billion), lower
marketing, administration and research costs ($274 million) and the shift in CDC
income ($27 million), partially offset by lower margins ($136 million, driven
primarily by higher dairy commodity-related costs) and the loss on the sale of a
North American food factory and integration costs ($82 million). On a pro forma
basis, operating companies income increased 9.6%.
The following discusses operating results within each of KFNA's reportable
segments.
Cheese, Meals And Enhancers: Reported volume in 2001 increased 8.3% over 2000,
due primarily to the acquisition of Nabisco. On a pro forma basis, volume in
2001 decreased 1.1%, due primarily to the 53rd week of shipments in 2000.
Excluding the 53rd week of shipments in 2000, volume increased 0.2%, as volume
gains in meals, enhancers and Canada were partially offset by declines in cheese
and food service. Meals recorded volume gains, reflecting higher shipments of
macaroni & cheese dinners. Enhancers also recorded volume gains, reflecting
higher shipments of spoonable and pourable dressings. In Canada, volume grew on
higher shipments of branded products. In cheese, shipments decreased, due
primarily to the Company's decision to exit the lower-margin, non-branded cheese
business. Volume also declined in process cheese loaves and cream cheese, as
retailers continued to reduce trade inventory levels, partially offset by higher
volume in grated and natural cheese. In U.S. food service, shipments declined
due to weakness in the economy and the Company's exit from lower-margin
businesses.
During 2001, reported net revenues increased $809 million (10.2%) over 2000, due
primarily to the acquisition of Nabisco ($791 million), higher net pricing ($122
million, primarily related to higher dairy commodity costs) and the shift in CDC
revenues ($29 million), partially offset by lower volume/mix ($65 million) and
unfavorable currency movements ($62 million). On a pro forma basis, net revenues
increased slightly from the comparable period of 2000, as higher pricing in
cheese and food service were partially offset by unfavorable currency and lower
volume/mix.
34
<Page>
Kraft Foods Inc.
Reported operating companies income for 2001 increased $254 million (13.8%) over
2000, due primarily to the acquisition of Nabisco ($234 million), lower
marketing, administration and research costs ($140 million, primarily lower
marketing expense) and the shift in CDC income ($15 million), partially offset
by unfavorable margins ($48 million, due primarily to higher dairy commodity
costs) and the loss on the sale of a North American food factory and integration
costs ($63 million). On a pro forma basis, operating companies income increased
6.4%.
Biscuits, Snacks and Confectionery: Reported volume in 2001 increased more than
100% over 2000, due primarily to the acquisition of Nabisco. On a pro forma
basis, volume in 2001 increased 1.6% over 2000. Excluding the 53rd week of
shipments in 2000, volume also increased 1.6%, due primarily to new product
introductions in biscuits, partially offset by lower shipments of snack nuts.
During 2001, reported net revenues increased $4.8 billion, or more than 100%
over 2000, due primarily to the acquisition of Nabisco. On a pro forma basis,
net revenues increased 2.1%, due primarily to higher volume driven by new
biscuit products and higher pricing of biscuit and confectionery products.
Reported operating companies income for 2001 increased $866 million, or more
than 100% over 2000, due primarily to the acquisition of Nabisco ($925 million),
partially offset by higher marketing, administration and research costs ($27
million). On a pro forma basis, operating companies income increased 24.9%, due
primarily to higher volume from new biscuit products, lower commodity costs for
snack nuts, and productivity and Nabisco synergy savings.
Beverages, Desserts and Cereals: Reported volume in 2001 increased 9.8% over
2000, due primarily to growth in beverages. On a pro forma basis, volume in 2001
increased 7.7% over 2000. Excluding the 53rd week of shipments in 2000, volume
increased 9.3%, due primarily to increased shipments of ready-to-drink
beverages, benefiting from the introduction of new products. Desserts volume was
below the prior year, due to lower shipments of dry packaged desserts and frozen
toppings. Cereal volume declined, due primarily to weak category performance and
increased competition in the ready-to-eat cereal category.
During 2001, reported net revenues decreased $30 million (0.7%) from 2000, due
primarily to lower net pricing ($167 million, due primarily to coffee
commodity-related price reductions), partially offset by the acquisition of
Nabisco ($83 million), the acquisition of Balance Bar Co. ($20 million), the
shift in CDC revenues ($16 million) and higher volume/mix ($17 million). On a
pro forma basis, net revenues decreased 3.1%, reflecting commodity-related price
reductions on coffee products and lower shipments in desserts and cereals.
Reported operating companies income for 2001 increased $102 million (9.4%) over
2000, primarily reflecting lower marketing, administration and research costs
($139 million), the acquisition of Nabisco ($32 million), and the shift in CDC
income ($7 million), partially offset by unfavorable margins ($31 million) and
integration costs ($12 million). On a pro forma basis, operating companies
income increased 6.8%.
Oscar Mayer and Pizza: Reported volume in 2001 increased 0.8% over 2000.
Excluding the 53rd week of shipments in 2000, volume increased 2.3%, due to
volume gains in processed meats and pizza. The processed meats business
recorded volume gains in luncheon meats, hot dogs, bacon and soy-based meat
alternatives. Volume in the pizza business increased, driven by new products.
During 2001, reported net revenues increased $101 million (3.6%) over 2000, due
primarily to higher volume/mix ($75 million), the shift in CDC revenues ($11
million) and the acquisition of Boca Burger, Inc.
Reported operating companies income for 2001 increased $27 million (5.3%) over
2000, primarily reflecting higher volume/mix ($45 million), lower marketing,
administration and research costs ($22 million) and the shift in CDC income,
partially offset by unfavorable margins ($36 million, due primarily to higher
meat and cheese commodity costs).
Kraft Foods International
<Table>
<Caption>
(in millions)
- -----------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- -----------------------------------------------------------------------------------
Reported volume (in pounds):
Europe, Middle East and Africa 2,961 2,826 2,829
Latin America and Asia Pacific 2,059 2,057 803
- -----------------------------------------------------------------------------------
Total reported volume (in pounds) 5,020 4,883 3,632
Volume of businesses sold:
Europe, Middle East and Africa (1) (40)
Latin America and Asia Pacific (135) (172) (37)
Estimated impact of century date change:
Europe, Middle East and Africa 7
Latin America and Asia Pacific 7
Nabisco volume:
Europe, Middle East and Africa 44
Latin America and Asia Pacific 936
- -----------------------------------------------------------------------------------
Pro forma volume (in pounds) 4,885 4,710 4,549
===================================================================================
Reported net revenues:
Europe, Middle East and Africa $6,203 $5,936 $6,398
Latin America and Asia Pacific 2,035 2,328 1,212
- -----------------------------------------------------------------------------------
Total reported net revenues 8,238 8,264 7,610
Net revenues of businesses sold:
Europe, Middle East and Africa (131)
Latin America and Asia Pacific (68) (90) (21)
Estimated impact of century date change:
Europe, Middle East and Africa 14
Latin America and Asia Pacific 12
Nabisco net revenues:
Europe, Middle East and Africa 46
Latin America and Asia Pacific 1,028
- -----------------------------------------------------------------------------------
Pro forma net revenues $8,170 $8,174 $8,558
===================================================================================
</Table>
35
<Page>
Kraft Foods Inc.
Kraft Foods International (continued)
<Table>
<Caption>
(in millions)
- -----------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- -----------------------------------------------------------------------------------
Reported operating companies income:
Europe, Middle East and Africa $ 962 $ 861 $1,019
Latin America and Asia Pacific 368 378 189
- -----------------------------------------------------------------------------------
Total reported operating
companies income 1,330 1,239 1,208
Gains on sales of businesses:
Europe, Middle East and Africa (139)
Latin America and Asia Pacific (72) (8)
Operating companies income of businesses sold:
Europe, Middle East and Africa (32)
Latin America and Asia Pacific (10) (18) (3)
Integration costs:
Latin America and Asia Pacific 17
Separation programs:
Europe, Middle East and Africa 5
Latin America and Asia Pacific 2
Estimated impact of century date change:
Europe, Middle East and Africa 8
Latin America and Asia Pacific 5
Nabisco operating companies income:
Europe, Middle East and Africa 1
Latin America and Asia Pacific 70
- -----------------------------------------------------------------------------------
Pro forma operating
companies income $1,272 $1,213 $1,118
===================================================================================
</Table>
2002 compared with 2001
KFI's reported volume for 2002 increased 2.8% over 2001. On a pro forma basis,
volume for 2002 increased 3.7% over 2001, due primarily to acquisitions, new
product introductions, geographic expansion and marketing programs. This
increase in volume was partially offset by the impact of economic weakness in
several Latin American countries.
During 2002, reported net revenues decreased $26 million (0.3%) from 2001, due
primarily to unfavorable currency movements ($271 million), lower volume/mix
($36 million) and revenues of divested businesses ($22 million), partially
offset by the impact of acquisitions ($181 million) and higher net pricing ($122
million). On a pro forma basis, net revenues decreased slightly.
Reported operating companies income for 2002 increased $91 million (7.3%) over
2001, due primarily to gains on sales of businesses ($64 million), favorable
margins ($37 million, including productivity savings), lower marketing,
administration and research costs ($23 million, including synergy savings) and
the impact of acquisitions ($18 million), partially offset by lower volume/mix
($19 million), 2002 integration costs ($17 million) and income of divested
businesses ($8 million). On a pro forma basis, operating companies income
increased 4.9%, driven by productivity and synergy savings, partially offset by
lower volume/mix.
The following discusses operating results within each of KFI's reportable
segments.
Europe, Middle East and Africa: Reported and pro forma volume for 2002 increased
4.8% over 2001, driven by acquisitions and volume growth across most markets
including Italy, the United Kingdom, Sweden, the Ukraine, the Middle East and
Poland, partially offset by declines in Germany and Romania. Snacks volume
increased, benefiting from confectionery acquisitions in Russia and Poland, a
snacks acquisition in Turkey and new product introductions across the segment.
Snacks volume growth was moderated by a decline in Germany, reflecting
aggressive competitive activity, and in Romania, due to lower consumer
purchasing power. In beverages, volume increased in both coffee and refreshment
beverages. Coffee volume grew in most markets, driven by new product
introductions, and acquisitions in Romania, Morocco and Bulgaria. In Germany,
coffee volume decreased, reflecting market softness and increased price
competition. Refreshment beverages volume also increased, driven by the
geographic expansion of powdered beverages and new product introductions. Cheese
volume increased with gains in Philadelphia cream cheese, benefiting from
advertising and new product introductions. In convenient meals, volume
increased, due primarily to higher canned meats volume in Italy against a weak
comparison in 2001, and new product introductions of lunch combinations in the
United Kingdom.
Reported and pro forma net revenues for 2002 increased $267 million (4.5%) over
2001, due primarily to favorable currency movements ($197 million), the
acquisitions of coffee, confectionery and snacks businesses ($147 million) and
higher volume/mix ($22 million), partially offset by lower net pricing
($99 million, due primarily to commodity-driven coffee price declines).
Reported operating companies income for 2002 increased $101 million (11.7%) over
2001, due primarily to favorable margins ($42 million), favorable currency
movements ($37 million), higher volume/mix ($19 million) and acquisitions ($16
million), partially offset by higher marketing, administration and research
costs. On a pro forma basis, operating companies income increased 12.3%.
Latin America and Asia Pacific: Reported volume for 2002 increased slightly over
2001. On a pro forma basis, volume for 2002 increased 2.1% over 2001, driven by
the acquisition of a biscuits business in Australia and gains across numerous
markets, partially offset by a volume decline in Argentina due to economic
weakness, and lower results in China. In snacks, volume growth was driven by
gains in biscuits, benefiting from geographic expansion of cookies and crackers
in Latin America, new product introductions and the acquisition of a biscuits
business in Australia. Snacks volume growth was partially offset by the negative
impact of the continued economic weakness in Argentina and distributor inventory
reductions in China. Beverages volume also increased, due primarily to growth in
powdered beverages in numerous markets across Latin America
36
<Page>
Kraft Foods Inc.
and Asia Pacific, which benefited from new product introductions. In grocery,
volume declined in both Latin America and Asia Pacific. Continued instability of
the economic climate in Argentina, Brazil and Venezuela is expected to
negatively impact volume and income in the Latin America and Asia Pacific
segment during 2003.
During 2002, reported net revenues decreased $293 million (12.6%) from 2001, due
primarily to unfavorable currency movements ($468 million), lower volume/mix
($58 million) and revenues from divested businesses ($22 million), partially
offset by higher net pricing ($221 million) and the 2002 acquisition of a
biscuits business in Australia ($34 million). On a pro forma basis, net revenues
decreased 12.1%.
Reported operating companies income for 2002 decreased $10 million (2.6%) from
2001, due primarily to lower volume/mix ($38 million), unfavorable currency
movements ($37 million), 2002 integration costs ($17 million) and the operating
companies income of disposed businesses, partially offset by gains on sales of
businesses ($64 million) and lower marketing, administration and research costs
($31 million, including synergy savings). On a pro forma basis, operating
companies income decreased 13.4%, due primarily to the devaluation driven cost
increase in Latin America and lower volume/mix, partially offset by synergy
savings.
2001 compared with 2000
KFI's reported volume for 2001 increased 34.4% over 2000, due primarily to the
acquisition of Nabisco. On a pro forma basis, volume for 2001 increased 3.5%
over 2000. Excluding the 53rd week of shipments in 2000, volume increased 4.8%,
benefiting from gains across most consumer sectors and driven by growth in the
developing markets of Central and Eastern Europe, Latin America and Asia
Pacific.
During 2001, reported net revenues increased $654 million (8.6%) over 2000, due
primarily to the acquisition of Nabisco ($1.2 billion) and the shift in CDC
revenues ($26 million), partially offset by unfavorable currency movements ($431
million) and the revenues of divested businesses. On a pro forma basis, net
revenues decreased 4.5%, primarily reflecting unfavorable currency movements.
Reported operating companies income for 2001 increased $31 million (2.6%) over
2000, due primarily to the acquisition of Nabisco ($128 million), lower
marketing, administration and research costs ($131 million) and the shift in CDC
income ($13 million), partially offset by the gain on the sale of a French
confectionery business in 2000 ($139 million), unfavorable currency movements
($51 million), unfavorable margins ($14 million) and income of divested
businesses. On a pro forma basis, operating companies income increased 8.5%.
The following discusses operating results within each of KFI's reportable
segments.
Europe, Middle East and Africa: Reported and pro forma volume for 2001 decreased
slightly from 2000, due primarily to the 53rd week of shipments in 2000.
Excluding the 53rd week of shipments in 2000, volume increased 1.3%, due
primarily to volume gains in the developing markets of Central and Eastern
Europe and growth in many Western European markets, partially offset by lower
volume in Germany, reflecting increased price competition and trade inventory
reductions, and lower canned meats volume in Italy. In beverages, volume
increased in both coffee and refreshment beverages. Coffee volume grew in many
markets, driven by new product introductions and recent acquisitions in Romania,
Morocco and Bulgaria. In Germany, coffee volume increased despite trade
inventory reductions. Refreshment beverages volume increased, driven by higher
sales to the Middle East. Snacks volume increased, driven by confectionery and
salted snacks, particularly in Central and Eastern Europe. Snacks volume in
Germany was lower due to increased price competition and trade inventory
reductions. Cheese volume increased, due primarily to Philadelphia cream cheese
growth across the region, partially offset by lower volume in Germany. In
convenient meals and grocery, volume declined as lower canned meats volume in
Italy and a decline in grocery volume in Germany were partially offset by higher
shipments of lunch combinations and pourable dressings in the United Kingdom.
Reported net revenues for 2001 decreased $462 million (7.2%) from 2000, due
primarily to unfavorable currency movements ($231 million), revenues from
divested businesses, lower net pricing ($122 million, primarily commodity-driven
coffee price decreases) and lower volume/mix ($69 million), partially offset by
the acquisition of Nabisco ($46 million), the 2001 acquisitions of coffee
businesses in Romania, Morocco and Bulgaria ($28 million) and the shift in CDC
revenues ($14 million). On a pro forma basis, net revenues decreased 6.2%,
reflecting unfavorable currency movements and commodity-related coffee price
decreases.
Reported operating companies income for 2001 decreased $158 million (15.5%) from
2000, due primarily to the gain on the sale of a French confectionery business
in 2000 ($139 million), unfavorable currency movements ($19 million), income
from divested businesses, lower volume/mix ($12 million) and unfavorable margins
($7 million), partially offset by lower marketing, administration and research
costs ($42 million) and the shift in CDC income. On a pro forma basis, operating
companies income increased 0.5%.
Latin America and Asia Pacific: Reported volume for 2001 increased more than
100% from 2000, due primarily to the acquisition of Nabisco. On a pro forma
basis, volume for 2001 increased 10.3% over 2000. Excluding the 53rd week of
shipments in 2000, volume increased 10.6%, due to gains across most consumer
sectors. Beverages volume increased, due primarily to growth in refreshment
beverages in Latin America and Asia Pacific, and coffee in Asia Pacific. Cheese
volume increased, due primarily to cream cheese and process cheese. Grocery
volume was higher, due primarily to new product introductions. Snacks volume
increased, driven primarily by new biscuit product introductions and geographic
expansion, partially offset by lower volume in Argentina, due to economic
weakness.
37
<Page>
Kraft Foods Inc.
During 2001, reported net revenues increased $1,116 million (92.1%) over 2000,
due primarily to the acquisition of Nabisco, partially offset by unfavorable
currency movements. On a pro forma basis, net revenues increased 0.3%.
Reported operating companies income for 2001 increased $189 million (100.0%)
over 2000, due primarily to the acquisition of Nabisco ($128 million), lower
marketing, administration and research costs ($89 million) and the shift in CDC
income, partially offset by unfavorable currency movements ($32 million). On a
pro forma basis, operating companies income increased 34.9%, due primarily to
productivity savings and Nabisco synergies.
Financial Review
Net Cash Provided by Operating Activities
Net cash provided by operating activities was $3.7 billion in 2002 and $3.3
billion in 2001 and 2000. The increase in 2002 operating cash flows over 2001
primarily reflected cash flow from increased net earnings.
Net Cash Used in Investing Activities
One element of the growth strategy of the Company is to strengthen its brand
portfolios through disciplined programs of selective acquisitions and
divestitures. The Company is constantly investigating potential acquisition
candidates and from time to time sells businesses that are outside its core
categories or that do not meet its growth or profitability targets.
During 2002, 2001 and 2000, net cash used in investing activities was $1.1
billion, $1.2 billion and $16.1 billion, respectively. The decrease in 2002
primarily reflected lower purchases of businesses and higher cash received from
the sales of businesses, partially offset by higher capital expenditures related
to the integration of Nabisco. The cash used in 2000 primarily reflected cash
used for the acquisition of Nabisco.
Capital expenditures, which were funded by operating activities, were $1.2
billion, $1.1 billion and $906 million in 2002, 2001 and 2000, respectively. The
capital expenditures were primarily to modernize the manufacturing facilities,
lower cost of production and expand production capacity for growing product
lines. In 2003, capital expenditures are expected to be at or slightly below
2002 expenditures and are expected to be funded from operations.
Net Cash Used in Financing Activities
During 2002, net cash of $2.6 billion was used in financing activities, compared
with $2.1 billion during 2001. The increase in cash used was due primarily to
dividends paid during 2002 and repurchases of the Company's Class A common
stock. During 2002, the Company issued $2.5 billion of global bonds and $750
million of floating rate notes, the proceeds of which were used to repay
outstanding indebtedness. Financing activities included net debt repayments of
approximately $1.5 billion in 2002.
During 2001, net cash of $2.1 billion was used in financing activities, compared
with $13.0 financing activities during 2000. During 2001, financing activities
included net debt repayments of $2.0 billion, debt repayments of made with IPO
proceeds. The net proceeds from the IPO were used to repay debt to Altria Group,
Inc. and affiliates, and, as a result, had no impact on financing cash flows. In
2000, the Company's financing activities provided cash, as additional borrowings
to finance the acquisition of Nabisco exceeded the cash used to pay dividends.
Debt and Liquidity
The SEC issued Financial Reporting Release No. 61, which sets forth the views of
the SEC regarding enhanced disclosures relating to liquidity and capital
resources. The information provided below about the Company's debt, credit
facilities, guarantees and future commitments is included here to facilitate a
review of the Company's liquidity.
Debt: The Company's total debt, including amounts due to Altria Group, Inc. and
affiliates, was $14.4 billion at December 31, 2002 and $16.0 billion at December
31, 2001. Aggregate prepayments of $3.9 billion on the 7.0% note payable to
Altria Group, Inc. and affiliates and repayments of short-term borrowings were
partially offset by an increase in long-term debt.
In April 2002, the Company filed a Form S-3 shelf registration statement with
the Securities and Exchange Commission, under which the Company may sell debt
securities and/or warrants to purchase debt securities in one or more offerings
up to a total amount of $5.0 billion. In May 2002, the Company issued
$2.5 billion of global bonds under the shelf registration. The bond offering
included $1.0 billion of five-year notes bearing interest at a rate of 5.25% and
$1.5 billion of ten-year notes bearing interest at a rate of 6.25%. The net
proceeds from the offering were used to retire maturing long-term debt in the
amount of $400 million and to prepay a portion (approximately $2.1 billion) of
the Company's 7.0% long-term note payable to Altria Group, Inc. and affiliates.
In November 2002, the Company issued $750 million of floating rate notes due in
2004 under the shelf registration. The interest rate on the notes is based on
the three-month London Interbank Offered Rate plus 0.20% and will be reset
quarterly. The net proceeds from the offering were used to prepay a portion of
the Company's 7.0% long-term note payable to Altria Group, Inc. and affiliates.
At December 31, 2002, the Company had $1,750 million of capacity remaining under
its existing $5.0 billion shelf registration statement.
During 2002, the Company prepaid $3,850 million of the 7.0% long-term notes
payable to Altria Group, Inc. and affiliates. In addition, at December 31, 2002,
the Company had short-term debt totaling $2,305 million to Altria Group, Inc.
and affiliates. Interest on these borrowings is based on the average one-month
London Interbank Offered Rate. A portion of the short-term debt, totaling $1,410
million, was reclassified on the consolidated balance sheet as long-term notes
due to Altria Group, Inc. and affiliates based upon the Company's ability and
intention to refinance such amounts on a long-term basis.
38
<Page>
Kraft Foods Inc.
As discussed in Notes 3, 7 and 8 to the consolidated financial statements, the
Company's total debt of $14.4 billion at December 31, 2002, which includes
borrowings from Altria Group, Inc. and affiliates, is due to be repaid as
follows: in 2003, $4.3 billion; in 2004-2005, $1.6 billion; in 2006-2007, $2.6
billion; and thereafter, $5.9 billion. Debt obligations due to be repaid in 2003
will be satisfied with a combination of short-term borrowings, long-term
borrowings and operating cash flows. The Company's debt-to-equity ratio was 0.56
at December 31, 2002 and 0.68 at December 31, 2001.
Credit Ratings: The Company's credit ratings by Moody's at December 31, 2002
were "P-1" in the commercial paper market and "A2" for long-term debt
obligations. The Company's credit ratings by Standard & Poor's at December 31,
2002 were "A-1" in the commercial paper market and "A-" for long-term debt
obligations. The Company's credit ratings by Fitch Rating Services at December
31, 2002 were "F-1" in the commercial paper market and "A" for long-term debt
obligations. Changes in the Company's credit ratings, although none are
currently anticipated, could result in corresponding changes in the Company's
borrowing costs. However, none of the Company's debt agreements require
accelerated repayment in the event of a decrease in credit ratings.
Credit Lines: The Company and its subsidiaries maintain credit lines with a
number of lending institutions, amounting to $5.6 billion at December 31, 2002.
Approximately $5.4 billion of these lines were undrawn at December 31, 2002.
Certain of these credit lines were used to support commercial paper borrowings
of $1.4 billion at December 31, 2002, the proceeds of which were used for
general corporate purposes. Approximately $600 million of these credit lines are
available to meet the short-term working capital needs of the Company's
international businesses. At December 31, 2002, the Company's credit lines also
include a $2.0 billion, five-year revolving credit facility expiring in July
2006 and a $3.0 billion 364-day revolving credit facility expiring in July 2003.
These credit facilities require the maintenance of a minimum net worth, as
defined in the credit facility, of $18.2 billion, which the Company met at
December 31, 2002. The Company does not currently anticipate any difficulty in
continuing to meet this covenant requirement. The foregoing revolving credit
facilities do not include any other financial tests, any credit rating triggers
or any provisions that could require the posting of collateral. The five-year
revolving credit facility enables the Company to reclassify short-term debt on a
long-term basis. At December 31, 2002, $1.4 billion of commercial paper
borrowings that the Company intends to refinance were reclassified as long-term
debt. The Company expects to continue to refinance long-term and short-term debt
from time to time. The nature and amount of the Company's long-term and
short-term debt and the proportionate amount of each can be expected to vary as
a result of future business requirements, market conditions and other factors.
Guarantees and Commitments: As discussed in Note 17 to the consolidated
financial statements, the Company had third-party guarantees, which are
primarily derived from acquisition and divestiture activities, of $36 million at
December 31, 2002. Substantially all of these guarantees expire through 2012,
with $12 million expiring in 2003. The Company is required to perform under
these guarantees in the event that a third fails to make contractual payments or
achieve performance measures. The Company has recorded a liability of $21
million at December 31, 2002 relating to these guarantees. In addition, at
December 31, 2002, the Company was contingently liable for $58 million of
guarantees related to its own performance. These include surety bonds related to
dairy commodity purchases and guarantees related to letters of credit.
Guarantees do not have, and are not expected to have, a significant impact on
the Company's liquidity.
The Company's consolidated rent expense for 2002 was $437 million. Accordingly,
the Company does not consider its lease commitments to be a significant
determinant of the Company's liquidity.
-----------------
The Company believes that its cash from operations, existing credit facilities
and access to global capital markets will provide sufficient liquidity to meet
its working capital needs, planned capital expenditures and payment of its
anticipated quarterly dividends.
Equity and Dividends
Dividends paid in 2002 and 2001 were $936 million and $225 million,
respectively, reflecting the payment of four quarterly dividends during 2002,
compared with one during 2001, as well as a higher dividend rate in 2002. During
the third quarter of 2002, the Company's Board of Directors approved a 15.4%
increase in the quarterly dividend rate to $0.15 per share on its Class A and
Class B common stock. As a result, the present annualized dividend rate is $0.60
per common share. The declaration of dividends is subject to the discretion of
the Company's Board of Directors and will depend on various factors, including
the Company's net earnings, financial condition, cash requirements, future
prospects and other factors deemed relevant by the Company's Board of Directors.
On June 21, 2002, the Company's Board of Directors approved the repurchase from
time to time of up to $500 million of the Company's Class A common stock solely
to satisfy the obligations of the Company to provide shares under its 2001
Performance Incentive Plan, 2001 Director Plan for non-employee directors, and
other plans where options to purchase the Company's Class A common stock are
granted to employees of the Company. During 2002, the Company repurchased
approximately 4.4 million shares of its Class A common stock at a cost of $170
million.
Concurrently with the IPO, certain employees of Altria Group, Inc. and its
subsidiaries (other than the Company) received a one-time grant of options to
purchase shares of the Company's Class A common stock held by Altria Group, Inc.
at the IPO price of $31.00 per share. In order to completely satisfy this
obligation and maintain its current percentage ownership of the Company, Altria
Group, Inc. purchased 1.6 million shares of the Company's Class A common stock
in open market transactions during 2002.
39
<Page>
Kraft Foods Inc.
Market Risk
The Company operates globally, with manufacturing and sales facilities in
various locations around the world, and utilizes certain financial instruments
to manage its foreign currency and commodity exposures, which primarily relate
to forecasted transactions. Derivative financial instruments are used by the
Company, principally to reduce exposures to market risks resulting from
fluctuations in foreign exchange rates and commodity prices by creating
offsetting exposures. The Company is not a party to leveraged derivatives and,
by policy, does not use financial instruments for speculative purposes.
Substantially all of the Company's derivative financial instruments are
effective as hedges under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." During the years ended December 31, 2002 and 2001,
ineffectiveness related to cash flow hedges was not material. At December 31,
2002, the Company is hedging forecasted transactions for periods not exceeding
fifteen months and expects substantially all amounts reported in accumulated
other comprehensive earnings (losses) to be reclassified to the consolidated
statement of earnings within the next twelve months.
Foreign Exchange Rates: The Company uses forward foreign exchange contracts and
foreign currency options to mitigate its exposure to changes in foreign currency
exchange rates from third-party and intercompany forecasted transactions. The
primary currencies to which the Company is exposed, based on the size and
location of its operations, include the euro, British pound and Canadian dollar.
At December 31, 2002 and 2001, the Company had option and forward foreign
exchange contracts with aggregate notional amounts of $575 million and $431
million, respectively, which are comprised of contracts for the purchase and
sale of foreign currencies. The effective portion of unrealized gains and losses
associated with forward contracts is deferred as a component of accumulated
other comprehensive earnings (losses) until the underlying hedged transactions
are reported on the Company's consolidated statement of earnings.
Commodities: The Company is exposed to price risk related to forecasted
purchases of certain commodities used as raw materials by the Company's
businesses. Accordingly, the Company uses commodity forward contracts, as cash
flow hedges, primarily for coffee, cocoa, milk and cheese. Commodity futures and
options are also used to hedge the price of certain commodities, including milk,
coffee, cocoa, wheat, corn, sugar and soybean oil. In general, commodity forward
contracts qualify for the normal purchase exception under SFAS No. 133 and are,
therefore, not subject to the provisions of SFAS No.133. At December 31, 2002
and 2001, the Company had net long commodity positions of $544 million and $589
million, respectively. Unrealized gains or losses on net commodity positions
were immaterial at December 31, 2002 and 2001. The effective portion of
unrealized gains and losses on commodity futures and option contracts is
deferred as a component of accumulated other comprehensive earnings (losses) and
is recognized as a component of cost of sales in the Company's consolidated
statement of earnings when the related inventory is sold.
Value at Risk: The Company uses a value at risk ("VAR") computation to estimate
the potential one-day loss in the fair value of its interest rate-sensitive
financial instruments and to estimate the potential one-day loss in pre-tax
earnings of its foreign currency and commodity component of cost sales in the
Company's consolidated price-sensitive derivative financial instruments. The VAR
statement of earnings when the related inventory is sold. computation includes
the Company's debt; short-term investments; foreign currency forwards, swaps and
options; and commodity futures, forwards and options. Anticipated transactions,
foreign currency trade payables and receivables, and net investments in foreign
subsidiaries, which the foregoing instruments are intended to hedge, were
excluded from the computation.
The VAR estimates were made assuming normal market conditions, using a 95%
confidence interval. The Company used a "variance/co-variance" model to
determine the observed interrelationships between movements in interest rates
and various currencies. These interrelationships were determined by observing
interest rate and forward currency rate movements over the preceding quarter for
the calculation of VAR amounts at December 31, 2002 and 2001, and over each of
the four preceding quarters for the calculation of average VAR amounts during
each year. The values of foreign currency and commodity options do not change on
a one-to-one basis with the underlying currency or commodity, and were valued
accordingly in the VAR computation.
The estimated potential one-day loss in fair value of the Company's interest
rate-sensitive instruments, primarily debt, under normal market conditions and
the estimated potential one-day loss in pre-tax earnings from foreign currency
and commodity instruments under normal market conditions, as calculated in the
VAR model, were as follows:
<Table>
<Caption>
Pre-Tax Earnings Impact
-------------------------------------------------
(in millions) At 12/31/02 Average High Low
- ----------------------------------------------------------------------------------
Instruments sensitive to:
Foreign currency rates $ 5 $ 2 $ 5 $ 1
Commodity prices 4 6 9 4
==================================================================================
</Table>
<Table>
<Caption>
Fair Value Impact
-------------------------------------------------
(in millions) At 12/31/02 Average High Low
- ----------------------------------------------------------------------------------
Instruments sensitive to:
Interest rates $ 76 $ 74 $ 76 $ 70
==================================================================================
</Table>
<Table>
<Caption>
Pre-Tax Earnings Impact
-------------------------------------------------
(in millions) At 12/31/02 Average High Low
- ----------------------------------------------------------------------------------
Instruments sensitive to:
Foreign currency rates $ 2 $ 6 $ 13 $ 2
Commodity prices 5 7 11 5
==================================================================================
</Table>
<Table>
<Caption>
Fair Value Impact
-------------------------------------------------
(in millions) At 12/31/02 Average High Low
- ----------------------------------------------------------------------------------
Instruments sensitive to:
Interest rates $ 122 $ 79 $ 122 $ 56
==================================================================================
</Table>
40
<Page>
Kraft Foods Inc.
This VAR computation is a risk analysis tool designed to statistically estimate
the maximum probable daily loss from adverse movements in interest rates,
foreign currency rates and commodity prices under normal market conditions. The
computation does not purport to represent actual losses in fair value or
earnings to be incurred by the Company, nor does it consider the effect of
favorable changes in market rates. The Company cannot predict actual future
movements in such market rates and does not present these VAR results to be
indicative of future movements in such market rates or to be representative of
any actual impact that future changes in market rates may have on its future
results of operations or financial position.
New Accounting Standards
As previously discussed, on January 1, 2002, the Company adopted SFAS No. 141,
"Business Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets,"
Emerging Issues Task Force ("EITF") Issue No. 00-14, "Accounting for Certain
Sales Incentives" and EITF Issue No. 00-25, "Vendor Income Statement
Characterization of Consideration Paid to a Reseller of the Vendor's Products."
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of." SFAS No. 144 provides updated guidance concerning the recognition
and measurement of an impairment loss for certain types of long-lived assets,
expands the scope of a discontinued operation to include a component of an
entity and eliminates the exemption to consolidation when control over a
subsidiary is likely to be temporary. The adoption of this new standard did not
have a material impact on the Company's consolidated financial position, results
of operations or cash flows.
In July 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS
No. 146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Costs covered by SFAS No. 146 include lease termination
costs and certain employee severance costs that are associated with a
restructuring, discontinued operation, plant closing or other exit or disposal
activity. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. Accordingly, the Company will apply the
provisions of SFAS No. 146 prospectively to exit or disposal activities
initiated after December 31, 2002.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." Interpretation No. 45 requires the disclosure of
certain guarantees existing at December 31, 2002. In addition, Interpretation
No. 45 requires the recognition of a liability for the fair value of the
obligation of qualifying guarantee activities that are initiated or modified
after December 31, 2002. Accordingly, the Company will apply the recognition
provisions of Interpretation No. 45 prospectively to guarantee activities
initiated after December 31, 2002.
In November 2002, the EITF issued EITF Issue No. 00-21, "Revenue Arrangements
with Multiple Deliverables," which addresses certain aspects of the accounting
by a vendor for arrangements under which it will perform multiple
revenue-generating activities. Specifically, EITF Issue No. 00-21 addresses how
to determine whether an arrangement involving multiple deliverables contains
more than one unit of accounting. EITF Issue No. 00-21 is effective for the
Company for revenue arrangements entered into beginning July 1, 2003. The
Company does not expect the adoption of EITF Issue No. 00-21 to have a material
impact on its 2003 consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation No. 46 requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the company that has the
controlling financial interest. Interpretation No. 46 also provides the
framework for determining whether a variable interest entity should be
consolidated based on voting interests or significant financial support provided
to it. Interpretation No. 46 will be effective for the Company on February 1,
2003 for variable interest entities created after January 31, 2003, and on July
1, 2003 for variable interest entities created prior to February 1, 2003. The
Company does not expect the adoption of Interpretation No. 46 to have a material
impact on its 2003 consolidated financial statements.
Contingencies
See Note 17 to the consolidated financial statements for a discussion of
contingencies.
41
<Page>
Kraft Foods Inc.
Forward-Looking and Cautionary Statements
The Company and its representatives may from time to time make written or oral
forward-looking statements, including statements contained in the Company's
filings with the SEC and in its reports to shareholders. One can identify these
forward-looking statements by use of words such as "strategy," "expects,"
"plans," "anticipates," "believes," "will," "continues," "estimates," "intends,"
"projects," "goals," "targets" and other words of similar meaning. One can also
identify them by the fact that they do not relate strictly to historical or
current facts. These statements are based on our assumptions and estimates and
are subject to risks and uncertainties. In connection with the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, the Company
is hereby identifying important factors that could cause actual results and
outcomes to differ materially from those contained in any forward-looking
statement made by or on behalf of the Company; any such statement is qualified
by reference to the following cautionary statements.
Each of the Company's segments is subject to intense competition, changes in
consumer preferences, the effects of changing prices for its raw materials
and local economic conditions. Their results are dependent upon their
continued ability to promote brand equity successfully, to anticipate and
respond to new consumer trends, to develop new products and markets, to
broaden brand portfolios in order to compete effectively with lower priced
products in a consolidating environment at the retail and manufacturing
levels, and to improve productivity. The Company's results are also dependent
on its ability to consummate and successfully integrate acquisitions,
including its ability to derive cost savings from the integration of
Nabisco's operations with the Company. In addition, the Company is subject to
the effects of foreign economies, currency movements and fluctuations in
levels of customer inventories. The Company's benefit expense is subject to
the investment performance of pension plan assets, interest rates and cost
increases for medical benefits offered to employees and retirees. The food
industry continues to be subject to recalls if products become adulterated or
misbranded, liability if product consumption causes injury, ingredient
disclosure and labeling laws and regulations and the possibility that
consumers could lose confidence in the safety and quality of certain food
products. Developments in any of these areas, which are more fully described
elsewhere in this document and which descriptions are incorporated into this
section by reference, could cause the Company's results to differ materially
from results that have been or may be projected by or on behalf of the
Company. The Company cautions that the foregoing list of important factors is
not exclusive. Any forward-looking statements are made as of the date of the
document in which they appear. The Company does not undertake to update any
forward-looking statement that may be made from time to time by or on behalf
of the Company.
42
<Page>
Kraft Foods Inc.
Selected Financial Data -- Five-Year Review
<Table>
<Caption>
(in millions of dollars, except per share data)
- -----------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Summary of Operations:
Net revenues* $ 29,723 $ 29,234 $ 22,922 $ 23,430 $ 24,140
Cost of sales* 17,720 17,566 13,959 14,615 15,586
Operating income 6,114 4,884 4,012 3,579 3,535
Interest and other debt expense, net 847 1,437 597 539 536
Earnings before income taxes and minority interest 5,267 3,447 3,415 3,040 2,999
Pre-tax profit margin 17.7% 11.8% 14.9% 13.0% 12.4%
Provision for income taxes 1,869 1,565 1,414 1,287 1,367
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings 3,394 1,882 2,001 1,753 1,632
Basic EPS 1.96 1.17 1.38 1.20 1.12
Diluted EPS 1.96 1.17 1.38 1.20 1.12
Dividends declared per share 0.56 0.26 -- -- --
Weighted average shares (millions)--Basic 1,734 1,610 1,455 1,455 1,455
Weighted average shares (millions)--Diluted 1,736 1,610 1,455 1,455 1,455
- -----------------------------------------------------------------------------------------------------------------------------------
Capital expenditures 1,184 1,101 906 860 841
Depreciation 709 680 499 491 494
Property, plant and equipment, net 9,559 9,109 9,405 6,526 6,494
Inventories 3,382 3,026 3,041 2,563 2,570
Total assets 57,100 55,798 52,071 30,336 31,391
Long-term debt 10,416 8,134 2,695 433 483
Notes payable to Altria Group, Inc. and affiliates 2,560 5,000 21,407 6,602 6,234
Total debt 14,443 16,007 25,826 7,828 7,168
- -----------------------------------------------------------------------------------------------------------------------------------
Total deferred income taxes 4,917 4,565 942 789 707
Shareholders' equity 25,832 23,478 14,048 13,461 15,134
Common dividends declared as a % of Basic EPS 28.6% 22.2% -- -- --
Common dividends declared as a % of Diluted EPS 28.6% 22.2% -- -- --
Book value per common share outstanding 14.92 13.53 9.65 9.25 10.40
Market price per Class A common share--high/low 43.95-32.50 35.57-29.50 -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Closing price of Class A common share at year end 38.93 34.03 -- -- --
Price/earnings ratio at year end--Basic 20 29 -- -- --
Price/earnings ratio at year end--Diluted 20 29 -- -- --
Number of common shares outstanding at
year end (millions) 1,731 1,735 1,455 1,455 1,455
Number of employees 109,000 114,000 117,000 71,000 78,000
===================================================================================================================================
</Table>
*Kraft Foods Inc. adopted Emerging Issues Task Force ("EITF") statements
relating to the classification of vendor consideration and certain sales
incentives resulting in a reclassification of prior period data. The adoption of
the EITF statements had no impact on operating income, net earnings, or basic
and diluted EPS.
43
<Page>
Kraft Foods Inc.
Consolidated Balance Sheets
<Table>
<Caption>
(in millions of dollars)
- -----------------------------------------------------------------------------------------------------------------------------------
At December 31, 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 215 $ 162
Receivables (less allowances of $119 and $151) 3,116 3,131
Inventories:
Raw materials 1,372 1,281
Finished product 2,010 1,745
- -----------------------------------------------------------------------------------------------------------------------------------
3,382 3,026
Deferred income taxes 511 466
Other current assets 232 221
- -----------------------------------------------------------------------------------------------------------------------------------
Total current assets 7,456 7,006
Property, plant and equipment, at cost:
Land and land improvements 387 387
Buildings and building equipment 3,153 2,915
Machinery and equipment 10,108 9,264
Construction in progress 802 706
- -----------------------------------------------------------------------------------------------------------------------------------
14,450 13,272
Less accumulated depreciation 4,891 4,163
- -----------------------------------------------------------------------------------------------------------------------------------
9,559 9,109
Goodwill and other intangible assets, net 36,420 35,957
Prepaid pension assets 2,814 2,675
Other assets 851 1,051
- -----------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 57,100 $ 55,798
===================================================================================================================================
Liabilities
Short-term borrowings $ 220 $ 681
Current portion of long-term debt 352 540
Due to Altria Group, Inc. and affiliates 895 1,652
Accounts payable 1,939 1,897
Accrued liabilities:
Marketing 1,474 1,398
Employment costs 610 658
Other 1,316 1,821
Income taxes 363 228
- -----------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 7,169 8,875
Long-term debt 10,416 8,134
Deferred income taxes 5,428 5,031
Accrued postretirement health care costs 1,889 1,850
Notes payable to Altria Group, Inc. and affiliates 2,560 5,000
Other liabilities 3,806 3,430
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 31,268 32,320
- -----------------------------------------------------------------------------------------------------------------------------------
Contingencies (Note 17)
Shareholders' Equity
Class A common stock, no par value (555,000,000 shares issued in 2002 and 2001)
Class B common stock, no par value (1,180,000,000 shares issued and outstanding)
Additional paid-in capital 23,655 23,655
Earnings reinvested in the business 4,814 2,391
Accumulated other comprehensive losses (primarily currency translation adjustments) (2,467) (2,568)
- -----------------------------------------------------------------------------------------------------------------------------------
26,002 23,478
Less cost of repurchased stock (4,381,150 Class A shares) (170)
- -----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 25,832 23,478
- -----------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 57,100 $ 55,798
===================================================================================================================================
</Table>
See notes to consolidated financial statements.
44
<Page>
Kraft Foods Inc.
Consolidated Statements of Earnings
<Table>
<Caption>
(in millions of dollars, except per share data)
- -----------------------------------------------------------------------------------------------------------------------------------
For the years ended December 31, 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 29,723 $ 29,234 $ 22,922
Cost of sales 17,720 17,566 13,959
- -----------------------------------------------------------------------------------------------------------------------------------
Gross profit 12,003 11,668 8,963
Marketing, administration and research costs 5,709 5,748 4,588
Integration costs and a loss on sale of a food factory 111 82
Separation programs 142
Gains on sales of businesses (80) (8) (172)
Amortization of intangibles 7 962 535
- -----------------------------------------------------------------------------------------------------------------------------------
Operating income 6,114 4,884 4,012
Interest and other debt expense, net 847 1,437 597
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings before income taxes and minority interest 5,267 3,447 3,415
Provision for income taxes 1,869 1,565 1,414
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority interest 3,398 1,882 2,001
Minority interest in earnings, net 4
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings $ 3,394 $ 1,882 $ 2,001
===================================================================================================================================
Per share data:
Basic earnings per share $ 1.96 $ 1.17 $ 1.38
===================================================================================================================================
Diluted earnings per share $ 1.96 $ 1.17 $ 1.38
===================================================================================================================================
</Table>
See notes to consolidated financial statements.
45
<Page>
Kraft Foods Inc.
Consolidated Statements of Cash Flows
<Table>
<Caption>
(in millions of dollars)
- -----------------------------------------------------------------------------------------------------------------------------------
For the years ended December 31, 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Cash Provided By (Used In) Operating Activities
Net earnings $ 3,394 $ 1,882 $ 2,001
Adjustments to reconcile net earnings to operating cash flows:
Depreciation and amortization 716 1,642 1,034
Deferred income tax provision 278 414 245
Gains on sales of businesses (80) (8) (172)
Integration costs and a loss on sale of a food factory 111 82
Separation programs 142
Cash effects of changes, net of the effects from acquired and
divested companies:
Receivables, net 116 23 204
Inventories (220) (107) 175
Accounts payable (116) (73) 13
Income taxes 277 74 35
Other working capital items (552) (407) (195)
Increase in pension assets and postretirement liabilities, net (34) (245) (215)
(Decrease) increase in amount due to Altria Group, Inc. and affiliates (244) 138 104
Other (68) (87) 25
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,720 3,328 3,254
- -----------------------------------------------------------------------------------------------------------------------------------
Cash Provided By (Used In) Investing Activities
Capital expenditures (1,184) (1,101) (906)
Purchase of Nabisco, net of acquired cash (15,159)
Purchases of other businesses, net of acquired cash (122) (194) (365)
Proceeds from sales of businesses 219 21 300
Other 35 52 (8)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,052) (1,222) (16,138)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash Provided By (Used In) Financing Activities
Net (repayment) issuance of short-term borrowings (1,036) 2,505 (816)
Long-term debt proceeds 3,325 4,077 87
Long-term debt repaid (609) (705) (112)
Net proceeds from sale of Class A common stock 8,425
Proceeds from issuance of notes payable to Altria Group, Inc. and affiliates 15,000
Repayment of notes payable to Altria Group, Inc. and affiliates (3,850) (16,350) (124)
Increase in amounts due to Altria Group, Inc. and affiliates 660 142 143
Repurchase of Class A common stock (170)
Dividends paid (936) (225) (1,009)
Other (187)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (2,616) (2,131) 12,982
- -----------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 1 (4) (2)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
Increase (decrease) 53 (29) 96
Balance at beginning of year 162 191 95
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 215 $ 162 $ 191
===================================================================================================================================
Cash paid:
Interest $ 825 $ 1,433 $ 605
===================================================================================================================================
Income taxes $ 1,368 $ 1,058 $ 1,051
===================================================================================================================================
</Table>
See notes to consolidated financial statements.
46
<Page>
Kraft Foods Inc.
Consolidated Statements of Shareholders' Equity
<Table>
<Caption>
(in millions of dollars, except per share data)
- -----------------------------------------------------------------------------------------------------------------------------------
Accumulated Other
Comprehensive Earnings (Losses)
--------------------------------
Class A Earnings
and B Additional Reinvested Currency Cost of Total
Common Paid-in in the Translation Repurchased Shareholders'
Stock Capital Business Adjustments Other Total Stock Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balances, January 1, 2000 $-- $15,230 $ -- $(1,741) $ (28) $(1,769) $ -- $13,461
Comprehensive earnings:
Net earnings 2,001 2,001
Other comprehensive losses,
net of income taxes:
Currency translation
adjustments (397) (397) (397)
Additional minimum
pension liability (8) (8) (8)
- -----------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive losses (405)
- -----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings 1,596
- -----------------------------------------------------------------------------------------------------------------------------------
Dividends declared (1,009) (1,009)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 2000 -- 15,230 992 (2,138) (36) (2,174) -- 14,048
Comprehensive earnings:
Net earnings 1,882 1,882
Other comprehensive losses,
net of income taxes:
Currency translation
adjustments (298) (298) (298)
Additional minimum
pension liability (78) (78) (78)
Change in fair value of
derivatives accounted
for as hedges (18) (18) (18)
- -----------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive losses (394)
- -----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings 1,488
- -----------------------------------------------------------------------------------------------------------------------------------
Sale of Class A common stock
to public 8,425 8,425
Dividends declared
($0.26 per share) (483) (483)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 2001 -- 23,655 2,391 (2,436) (132) (2,568) -- 23,478
Comprehensive earnings:
Net earnings 3,394 3,394
Other comprehensive earnings
(losses), net of income taxes:
Currency translation
adjustments 187 187 187
Additional minimum
pension liability (117) (117) (117)
Change in fair value of
derivatives accounted
for as hedges 31 31 31
- -----------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive earnings 101
- -----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings 3,495
- -----------------------------------------------------------------------------------------------------------------------------------
Dividends declared
($0.56 per share) (971) (971)
Class A common stock
repurchased (170) (170)
- -----------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 2002 $-- $23,655 $4,814 $(2,249) $(218) $(2,467) $(170) $25,832
- -----------------------------------------------------------------------------------------------------------------------------------
</Table>
See notes to consolidated financial statements.
47
<Page>
Kraft Foods Inc.
Notes to Consolidated Financial Statements
NOTE 1. Background and Basis of Presentation:
Background: Kraft Foods Inc. ("Kraft") was incorporated in 2000 in the
Commonwealth of Virginia. Following Kraft's formation, Altria Group, Inc.
(formerly Philip Morris Companies Inc.), transferred to Kraft its ownership
interest in Kraft Foods North America, Inc. ("KFNA"), a Delaware corporation,
through a capital contribution. In addition, during 2000, a subsidiary of Altria
Group, Inc. transferred management responsibility for its food businesses in
Latin America to KFNA and its wholly-owned subsidiary, Kraft Foods
International, Inc. ("KFI"). Kraft, through its subsidiaries (Kraft and its
subsidiaries are hereinafter referred to as the "Company"), is engaged in the
manufacture and sale of branded foods and beverages in the United States,
Canada, Europe, Latin America, Asia Pacific and Middle East and Africa.
On December 11, 2000, the Company acquired all of the outstanding shares of
Nabisco Holdings Corp. ("Nabisco") for $55 per share in cash. See Note 5.
Acquisitions for a complete discussion of this transaction.
Prior to June 13, 2001, the Company was a wholly-owned subsidiary of Altria
Group, Inc. On June 13, 2001, the Company completed an initial public offering
("IPO") of 280,000,000 shares of its Class A common stock at a price of $31.00
per share. The IPO proceeds, net of the underwriting discount and expenses, of
$8.4 billion were used to retire a portion of an $11.0 billion long-term note
payable to Altria Group, Inc., incurred in connection with the acquisition of
Nabisco. After the IPO, Altria Group, Inc. owned approximately 83.9% of the
outstanding shares of the Company's capital stock through its ownership of 49.5%
of the Company's Class A common stock and 100% of the Company's Class B common
stock. The Company's Class A common stock has one vote per share, while the
Company's Class B common stock has ten votes per share. At December 31, 2002,
Altria Group, Inc. held 97.8% of the combined voting power of the Company's
outstanding capital stock and owned approximately 84.2% of the outstanding
shares of the Company's capital stock.
Basis of Presentation: The consolidated financial statements include Kraft and
its subsidiaries. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the dates of the financial statements and the reported amounts of
net revenues and expenses during the reporting periods. Significant estimates
and assumptions include, among other things, pension and benefit plan
assumptions and income taxes. Actual results could differ from those estimates.
The Company's operating subsidiaries report year-end results as of the Saturday
closest to the end of each year. This resulted in fifty-three weeks of operating
results in the Company's consolidated statement of earnings for the year ended
December 31, 2000.
Certain prior years' amounts have been reclassified to conform with the current
year's presentation, due primarily to the adoption of new accounting rules
regarding revenues, as well as the disclosure of more detailed information on
the consolidated statements of earnings and the consolidated statements of cash
flows.
Note 2. Summary of Significant Accounting Policies:
Cash and cash equivalents: Cash equivalents include demand deposits with banks
and all highly liquid investments with original maturities of three months or
less.
Depreciation, amortization and goodwill valuation: Property, plant and equipment
are stated at historical cost and depreciated by the straight-line method over
the estimated useful lives of the assets. Machinery and equipment are
depreciated over periods ranging from 3 to 20 years and buildings and building
improvements over periods up to 40 years.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill
and Other Intangible Assets." As a result, the Company stopped recording the
amortization of goodwill and indefinite life intangible assets as a charge to
earnings as of January 1, 2002. Net earnings and diluted earnings per share
("EPS") would have been as follows had the provisions of the new standards been
applied as of January 1, 2000:
<Table>
<Caption>
(in millions, except per share amounts)
- -------------------------------------------------------------------------------
For the years ended December 31, 2001 2000
- -------------------------------------------------------------------------------
Net earnings, as previously reported $1,882 $2,001
Adjustment for amortization of goodwill and
indefinite life intangibles 955 530
- -------------------------------------------------------------------------------
Net earnings, as adjusted $2,837 $2,531
===============================================================================
Diluted EPS, as previously reported $ 1.17 $ 1.38
Adjustment for amortization of goodwill and
indefinite life intangibles 0.59 0.36
- -------------------------------------------------------------------------------
Diluted EPS, as adjusted $ 1.76 $ 1.74
===============================================================================
</Table>
In addition, the Company is required to conduct an annual review of goodwill and
intangible assets for potential impairment. In 2002, the Company completed its
review and did not have to record a charge to earnings for an impairment of
goodwill or other intangible assets.
At December 31, 2002, goodwill by reportable segment was as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Cheese, Meals and Enhancers $ 8,556
Biscuits, Snacks and Confectionery 9,262
Beverages, Desserts and Cereals 2,143
Oscar Mayer and Pizza 616
- --------------------------------------------------------------------------------
Total Kraft Foods North America 20,577
- --------------------------------------------------------------------------------
Europe, Middle East and Africa 4,082
Latin America and Asia Pacific 252
- --------------------------------------------------------------------------------
Total Kraft Foods International 4,334
- --------------------------------------------------------------------------------
Total goodwill $24,911
================================================================================
</Table>
48
<Page>
Kraft Foods Inc.
Intangible assets as of December 31, 2002 were as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Gross
Carrying Accumulated
Amount Amortization
- --------------------------------------------------------------------------------
Non-amortizable intangible assets $11,485
Amortizable intangible assets 54 $30
- --------------------------------------------------------------------------------
Total intangible assets $11,539 $30
================================================================================
</Table>
Non-amortizable intangible assets are substantially comprised of brand names
purchased through the Nabisco acquisition. Amortizable intangible assets consist
primarily of certain trademark licenses and non-compete agreements. Pre-tax
amortization expense for intangible assets was $7 million for the year ended
December 31, 2002. Based upon the amortizable intangible assets recorded on the
consolidated balance sheet at December 31, 2002, amortization expense for each
of the next five years is estimated to be $8 million or less.
The increase in goodwill and other intangible assets, net, during the year ended
December 31, 2002, of $463 million is primarily related to currency translation,
partially offset by a $76 million decrease in goodwill relating to the favorable
completion of severance and exit programs associated with the Nabisco
acquisition.
Environmental costs: The Company is subject to laws and regulations relating to
the protection of the environment. The Company provides for expenses associated
with environmental remediation obligations on an undiscounted basis when such
amounts are probable and can be reasonably estimated. Such accruals are adjusted
as new information develops or circumstances change.
While it is not possible to quantify with certainty the potential impact of
actions regarding environmental remediation and compliance efforts that the
Company may undertake in the future, in the opinion of management, environmental
remediation and compliance costs, before taking into account any recoveries from
third parties, will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
Foreign currency translation: The Company translates the results of operations
of its foreign subsidiaries using average exchange rates during each period,
whereas balance sheet accounts are translated using exchange rates at the end of
each period. Currency translation adjustments are recorded as a component of
shareholders' equity. Transaction gains and losses are recorded in the
consolidated statements of earnings and were not significant for any of the
periods presented.
Guarantees: In November 2002, the Financial Accounting Standards Board
("FASB") issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." Interpretation No. 45 requires the disclosure of certain guarantees
existing at December 31, 2002. In addition, Interpretation No. 45 requires the
recognition of a liability for the fair value of the obligation of qualifying
guarantee activities that are initiated or modified after December 31, 2002.
Accordingly, the Company will apply the recognition provisions of
Interpretation No. 45 prospectively to guarantee activities initiated after
December 31, 2002. See Note 17. Contingencies for a further discussion of
guarantees.
Hedging instruments: Effective January 1, 2001, the Company adopted SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," and its
related amendment, SFAS No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities" (collectively referred to as "SFAS No. 133").
These standards require that all derivative financial instruments be recorded on
the consolidated balance sheets at their fair value as either assets or
liabilities. Changes in the fair value of derivatives are recorded each period
either in accumulated other comprehensive losses or in earnings, depending on
whether a derivative is designated and effective as part of a hedge transaction
and, if it is, the type of hedge transaction. Gains and losses on derivative
instruments reported in accumulated other comprehensive earnings (losses) are
reclassified to the consolidated statement of earnings in the periods in which
operating results are affected by the hedged item. Cash flow hedging instruments
are classified in the same manner as the affected hedged item in the
consolidated statements of cash flows. As of January 1, 2001, the adoption
of these new standards did not have a material effect on net earnings (less than
$1 million) or accumulated other comprehensive losses (less than $1 million).
Impairment of long-lived assets: The Company reviews long-lived assets,
including amortizable intangible assets, for impairment whenever events or
changes in business circumstances indicate that the carrying amount of the
assets may not be fully recoverable. The Company performs undiscounted operating
cash flow analyses to determine if an impairment exists. If an impairment is
determined to exist, any related impairment loss is calculated based on fair
value. Impairment losses on assets to be disposed of, if any, are based on the
estimated proceeds to be received, less costs of disposal.
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to
Be Disposed Of." SFAS No. 144 provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets, expands the scope of a discontinued operation to include a
component of an entity and eliminates the exemption to consolidation when
control over a subsidiary is likely to be temporary. The adoption of this new
standard did not have a material impact on the Company's consolidated financial
position, results of operations or cash flows.
49
<Page>
Kraft Foods Inc.
Income taxes: The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes." The accounts of the Company are included in
the consolidated federal income tax return of Altria Group, Inc. Income taxes
are generally computed on a separate company basis. To the extent that foreign
tax credits, capital losses and other credits generated by the Company, which
cannot be utilized on a separate company basis, are utilized in Altria Group,
Inc.'s consolidated federal income tax return, the benefit is recognized in the
calculation of the Company's provision for income taxes. The Company utilized
tax benefits that it would otherwise not have been able to use of $193 million,
$185 million and $139 million for the years ended December 31, 2002, 2001 and
2000, respectively. The Company makes payments to, or is reimbursed by, Altria
Group, Inc., for the tax effects resulting from its inclusion in Altria Group,
Inc.'s consolidated federal income tax return.
Inventories: Inventories are stated at the lower of cost or market. The last-in,
first-out ("LIFO") method is used to cost substantially all domestic
inventories. The cost of other inventories is principally determined by the
average cost method.
Marketing costs: The Company promotes its products with significant marketing
activities, including advertising, consumer incentives and trade promotions.
Advertising costs are expensed as incurred. Consumer incentive and trade
promotion activities are recorded as a reduction of revenues based on amounts
estimated as being due to customers and consumers at the end of a period, based
principally on historical utilization and redemption rates.
Revenue recognition: The Company recognizes revenues, net of sales incentives
and including shipping and handling charges billed to customers, upon shipment
of goods when title and risk of loss pass to customers. Shipping and handling
costs are classified as part of cost of sales.
Effective January 1, 2002, the Company adopted the Emerging Issues Task Force
("EITF") Issue No. 00-14, "Accounting for Certain Sales Incentives" and EITF
Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid
to a Reseller of the Vendor's Products." Prior period consolidated statements of
earnings have been reclassified to reflect the adoption. The adoption of these
EITF Issues resulted in a reduction of revenues of approximately $4.6 billion
and $3.6 billion in 2001 and 2000, respectively. In addition, the adoption
reduced marketing, administration and research costs by $4.7 billion and $3.7
billion in 2001 and 2000, respectively, while cost of sales increased by an
insignificant amount. The adoption of these EITF Issues had no impact on
operating income, net earnings or basic and diluted EPS.
Software costs: The Company capitalizes certain computer software and software
development costs incurred in connection with developing or obtaining
computer software for internal use. Capitalized software costs are amortized
on a straight-line basis over the estimated useful lives of the software,
which do not exceed five years.
Stock-based compensation: The Company accounts for employee stock compensation
plans in accordance with the intrinsic value-based method permitted by SFAS No.
123, "Accounting for Stock-Based Compensation," which did not result in
compensation cost for stock options.
At December 31, 2002, the Company had stock-based employee compensation plans,
which are described more fully in Note 10. Stock Plans. The Company applies the
recognition and measurement principles of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related Interpretations
in accounting for those plans. No compensation expense for employee stock
options is reflected in net earnings as all options granted under those plans
had an exercise price equal to the market value of the common stock on the date
of the grant. Net earnings, as reported, includes compensation expense related
to restricted stock. The following table illustrates the effect on net earnings
and EPS if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation for the years ended December 31,
2002, 2001 and 2000:
<Table>
<Caption>
(in millions, except per share data)
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Net earnings, as reported $3,394 $1,882 $2,001
Deduct:
Total stock-based employee
compensation expense determined
under fair value method for all
stock option awards, net of related
tax effects 78 97 54
- --------------------------------------------------------------------------------
Pro forma net earnings $3,316 $1,785 $1,947
================================================================================
Earnings per share:
Basic--as reported $ 1.96 $ 1.17 $ 1.38
================================================================================
Basic--pro forma $ 1.91 $ 1.11 $ 1.34
================================================================================
Diluted--as reported $ 1.96 $ 1.17 $ 1.38
================================================================================
Diluted--pro forma $ 1.91 $ 1.11 $ 1.34
================================================================================
</Table>
New accounting pronouncements: In July 2002, the FASB issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Costs covered by SFAS No. 146 include lease termination
costs and certain employee severance costs that are associated with a
restructuring, discontinued operation, plant closing or other exit or disposal
activity. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. Accordingly, the Company will apply the
provisions of SFAS No. 146 prospectively to exit or disposal activities
initiated after December 31, 2002.
In November 2002, the EITF issued EITF Issue No. 00-21, "Revenue Arrangements
with Multiple Deliverables," which addresses certain aspects of the accounting
by a vendor for arrangements under which it will perform multiple
revenue-generating activities. Specifically, EIT Issue No. 00-21 addresses how
to determine whether an arrangement involving multiple
50
<Page>
Kraft Foods Inc.
deliverables contains more than one unit of accounting. EITF Issue No. 00-21 is
effective for the Company for revenue arrangements entered into beginning July
1, 2003. The Company does not expect the adoption of EITF Issue No. 00-21 to
have a material impact on its 2003 consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation No. 46 requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the company that has the
controlling financial interest. Interpretation No. 46 also provides the
framework for determining whether a variable interest entity should be
consolidated based on voting interests or significant financial support provided
to it. Interpretation No. 46 will be effective for the Company on February 1,
2003 for variable interest entities created after January 31, 2003, and on July
1, 2003 for variable interest entities created prior to February 1, 2003. The
Company does not expect the adoption of Interpretation No. 46 to have a material
impact on its 2003 consolidated financial statements.
Note 3. Related Party Transactions:
Altria Group, Inc.'s subsidiary, Altria Corporate Services, Inc., provides the
Company with various services, including planning, legal, treasury, accounting,
auditing, insurance, human resources, office of the secretary, corporate
affairs, information technology and tax services. In 2001, the Company entered
into a formal agreement with Altria Corporate Services, Inc., providing for a
continuation of these services, the cost of which increased $91 million during
2001 as Altria Corporate Services, Inc., provided information technology and
financial services, all of which were previously performed by the Company at
approximately the same cost. Billings for these services, which were based on
the cost to Altria Corporate Services, Inc. to provide such services and a
management fee, were $327 million, $339 million and $248 million for the years
ended December 31, 2002, 2001 and 2000, respectively. These costs were paid to
Altria Corporate Services, Inc. monthly. Although the cost of these services
cannot be quantified on a standalone basis, management believes that the
billings are reasonable based on the level of support provided by Altria
Corporate Services, Inc., and that they reflect all services provided. The cost
and nature of the services are reviewed annually by the Company's audit
committee, which is comprised of independent directors. The effects of these
transactions are included in operating cash flows in the Company's consolidated
statements of cash flows.
In addition, the Company's daily net cash or overdraft position is transferred
to Altria Group, Inc., or its European subsidiary. The Company pays or receives
interest based upon the applicable London Interbank Offered Rate, on the amounts
payable to, or receivable from, Altria Group, Inc., or its European subsidiary.
The Company also has long-term notes payable to Altria Group, Inc. and its
affiliates as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
At December 31, 2002 2001
- --------------------------------------------------------------------------------
Notes payable in 2009, interest at 7.0% $1,150 $5,000
Short-term due to Altria Group, Inc. and
affiliates reclassified as long-term 1,410
- --------------------------------------------------------------------------------
$2,560 $5,000
================================================================================
</Table>
The 7.0% notes have no prepayment penalty. During 2002, the Company prepaid
$3,850 million of the 7.0% long-term notes payable. In addition, at December 31,
2002, the Company has short-term debt totaling $2,305 million to Altria Group,
Inc. Interest on these borrowings is based on the average one-month London
Interbank Offered Rate. A portion of the debt, totaling $1,410 million, was
reclassified on the consolidated balance sheet as long-term notes due to Altria
Group, Inc. and affiliates based upon the Company's ability and intention to
refinance on a long-term basis.
Based on interest rates available to the Company for issuances of debt with
similar terms and remaining maturities, the aggregate fair value of the
Company's long-term notes payable to Altria Group, Inc. and affiliates, at
December 31, 2002 and 2001, were $2,764 million and $5,325 million,
respectively. The fair values of the Company's current amounts due to Altria
Group, Inc. and affiliates approximate carrying amounts.
Note 4. Divestitures:
During 2002, the Company sold several small North American food businesses, some
of which were previously classified as businesses held for sale. The net
revenues and operating results of the businesses held for sale, which were not
significant, were excluded from the Company's consolidated statements
of earnings, and no gain or loss was recognized on these sales. In addition, the
Company sold its Latin American yeast and industrial bakery ingredients business
for approximately $110 million and recorded a pre-tax gain of $69 million. The
aggregate proceeds received from sales of businesses were $219 million, on which
the Company recorded pretax gains of $80 million.
During 2001, the Company sold several small food businesses. The aggregate
proceeds received in these transactions were $21 million, on which the Company
recorded pre-tax gains of $8 million.
During 2000, the Company sold a French confectionery business for proceeds of
$251 million, on which a pre-tax gain of $139 million was recorded. Several
small international and North American food businesses were also sold in 2000.
The aggregate proceeds received from sales of businesses were $300 million, on
which the Company recorded pre-tax gains of $172 million.
The operating results of the businesses sold were not material to the Company's
consolidated operating results in any of the periods presented.
51
<Page>
Kraft Foods Inc.
Note 5. Acquisitions:
Nabisco: On December 11, 2000, the Company acquired all of the outstanding
shares of Nabisco for $55 per share in cash. The purchase of the outstanding
shares, retirement of employee stock options and other payments totaled
approximately $15.2 billion. In addition, the acquisition included the
assumption of approximately $4.0 billion of existing Nabisco debt. The
Company financed the acquisition through the issuance of two long-term notes
payable to Altria Group, Inc., totaling $15.0 billion, and short-term
intercompany borrowings of $255 million. The acquisition has been accounted
for as a purchase. Beginning January 1, 2001, Nabisco's earnings have been
included in the consolidated operating results of the Company. The Company's
interest cost associated with acquiring Nabisco has been included in interest
and other debt expense, net, on the Company's consolidated statements of
earnings for the years ended December 31, 2002, 2001 and 2000.
During 2001, the Company completed the allocation of excess purchase price
relating to Nabisco. As a result, the Company recorded, among other things, the
final valuations of property, plant and equipment and intangible assets,
primarily trade names, amounts relating to the closure of Nabisco facilities and
related deferred income taxes. The final allocation of excess purchase price at
December 31, 2001 was as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Purchase price $15,254
Historical value of tangible assets acquired and
liabilities assumed (1,271)
- --------------------------------------------------------------------------------
Excess of purchase price over assets acquired and
liabilities assumed at the date of acquisition 16,525
Increases for allocation of purchase price:
Property, plant and equipment 367
Other assets 347
Accrued postretirement health care costs 230
Pension liabilities 190
Debt 50
Legal, professional, lease and contract termination costs 129
Other liabilities, principally severance 602
Deferred income taxes 3,583
- --------------------------------------------------------------------------------
Goodwill and other intangible assets at December 31, 2001 $22,023
================================================================================
</Table>
Goodwill and other intangible assets at December 31, 2001 included approximately
$11.7 billion related to trade names. The Company also recorded deferred federal
income taxes of $3.9 billion related to trade names. During 2002, the Company
decreased goodwill by $76 million due primarily to the favorable completion of
the severance and exit programs.
The closure of a number of Nabisco domestic and international facilities
resulted in severance and other exit costs of $379 million, which are included
in the above adjustments for the allocation of the Nabisco purchases price. The
closures will result in the termination of approximately 7,500 employees and
will require total cash payments of $373 million, of which approximately $190
million has been spent through December 31, 2002. Substantially all of the
closures were completed as of December 31, 2002, and the remaining payments
relate to salary continuation payments for severed employees and lease
payments.
The integration of Nabisco into the operations of the Company has also resulted
in the closure or reconfiguration of several of the Company's existing
facilities. The aggregate charges to the Company's consolidated statement of
earnings to close or reconfigure its facilities and integrate Nabisco were
originally estimated to be in the range of $200 million to $300 million. During
2002, the Company recorded pre-tax integration related charges of $115 million
to consolidate production lines, close facilities and for other consolidation
programs. In addition, during 2001, the Company incurred pre-tax integration
costs of $53 million for site reconfigurations and other consolidation programs
in the United States. The integration related charges of $168 million included
$27 million relating to severance, $117 million relating to asset write-offs and
$24 million relating to other cash exit costs. Cash payments relating to these
charges will approximate $51 million, of which $21 million has been paid through
December 31, 2002. In addition, during 2002, approximately 700 salaried
employees elected to retire or terminate employment under voluntary retirement
programs. As a result, the Company recorded a pre-tax charge of $142 million
related to these programs. As of December 31, 2002, the aggregate pre-tax
charges to close or reconfigure the Company's facilities, including charges for
early retirement programs, were $310 million, slightly above the original
estimate. No additional pre-tax charges are expected to be recorded for these
programs.
During 2001, certain small Nabisco businesses were reclassified to businesses
held for sale, including their estimated results of operations through
anticipated sale dates. These businesses have subsequently been sold, with the
exception of one business that had been held for sale since the acquisition of
Nabisco. This business, which is no longer held for sale, has been included in
2002 consolidated operating results.
Assuming the acquisition of Nabisco occurred at the beginning of 2000, pro forma
net revenues would have been approximately $30 billion and pro forma net
earnings would have been $1.4 billion in 2000; while 2000 basic and diluted EPS
would have been $0.96. These pro forma results, which are unaudited, do not give
effect to any synergies expected to result from the merger of Nabisco's
operations with those of the Company, nor do they give effect to the reduction
of interest expense from the repayment of borrowings with the proceeds from the
IPO. The pro forma results also do not reflect the effects of SFAS No. 141 and
142 on the amortization of goodwill or other intangible assets. The pro forma
results are not necessarily indicative of what actually would have occurred if
the acquisition had been consummated and the IPO completed at the beginning of
2000, nor are they necessarily indicative of future consolidated operating
results.
52
<Page>
Kraft Foods Inc.
Other Acquisitions: During 2002, the Company acquired a snacks business in
Turkey and a biscuits business in Australia. The total cost of these and other
smaller acquisitions was $122 million.
During 2001, the Company purchased coffee businesses in Romania, Morocco and
Bulgaria and also acquired confectionery businesses in Russia and Poland. The
total cost of these and other smaller acquisitions was $194 million.
During 2000, the Company purchased Balance Bar Co. and Boca Burger, Inc. The
total cost of these and other smaller acquisitions was $365 million.
The effects of these acquisitions were not material to the Company's
consolidated financial position or results of operations in any of the periods
presented.
Note 6. Inventories:
The cost of approximately 49% and 54% of inventories in 2002 and 2001,
respectively, was determined using the LIFO method. The stated LIFO amounts of
inventories were approximately $215 million and $150 million higher than the
current cost of inventories at December 31, 2002 and 2001, respectively.
Note 7. Short-Term Borrowings and Borrowing Arrangements:
At December 31, 2002 and 2001, the Company had short-term borrowings of $1,621
million and $2,681 million, respectively, consisting principally of commercial
paper borrowings with an average year-end interest rate of 1.3% and 1.9%,
respectively. Of these amounts, the Company reclassified $1,401 million and
$2,000 million, respectively, of the commercial paper borrowings to long-term
debt based upon its intent and ability to refinance these borrowings on a
long-term basis.
The fair values of the Company's short-term borrowings at December 31, 2002 and
2001, based upon current market interest rates, approximate the amounts
disclosed above.
The Company has a $2.0 billion 5-year revolving credit facility maturing in July
2006 and a $3.0 billion 364-day revolving credit facility maturing in July 2003.
The Company intends to use these credit facilities to support commercial paper
borrowings, the proceeds of which will be used for general corporate purposes.
None of these facilities were drawn at December 31, 2002. These facilities
require the maintenance of a minimum net worth. The Company met this covenant at
December 31, 2002. In addition, the Company maintains credit lines with a number
of lending institutions amounting to approximately $577 million. The Company
maintains these credit lines primarily to meet the short-term working capital
needs of its international businesses. The foregoing revolving credit facilities
do not include any other financial tests, any credit rating triggers or any
provisions that could require the posting of collateral.
Note 8. Long-Term Debt:
At December 31, 2002 and 2001, the Company's long-term debt consisted of the
following:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------
Short-term borrowings, reclassified as
long-term debt $ 1,401 $2,000
Notes, 4.63% to 7.55% (average effective
rate 5.53%), due through 2035 9,053 6,229
7% Debenture (effective rate 11.32%),
$200 million face amount, due 2011 153 258
Foreign currency obligations 117 136
Other 44 51
- --------------------------------------------------------------------------------
10,768 8,674
Less current portion of long-term debt (352) (540)
- --------------------------------------------------------------------------------
$10,416 $8,134
================================================================================
</Table>
Aggregate maturities of long-term debt, excluding short-term borrowings
reclassified as long-term debt, are as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2003 $ 352
2004 838
2005 732
2006 1,255
2007 1,395
2008-2012 3,701
Thereafter 1,141
- --------------------------------------------------------------------------------
</Table>
Based on market quotes, where available, or interest rates currently available
to the Company for issuance of debt with similar terms and remaining maturities,
the aggregate fair value of the Company's long-term debt, including the current
portion of long-term debt, was $11,544 million and $8,679 million at
December 31, 2002 and 2001, respectively.
Note 9. Capital Stock:
The Company's articles of incorporation authorize 3.0 billion shares of Class A
common stock, 2.0 billion shares of Class B common stock and 500 million shares
of preferred stock. On June 21, 2002, the Company's Board of Directors
approved the repurchase from time to time of up to $500 million of the Company's
Class A common stock solely to satisfy the obligations of the Company under the
2001 Kraft Performance Incentive Plan, the Kraft Director Plan for non-employee
directors, and other plans where options to purchase the Company's Class A
common stock are granted. During 2002, the Company repurchased approximately 4.4
million shares of its Class A common stock at a cost of $170 million.
53
<Page>
Kraft Foods Inc.
Shares of Class A common stock issued, repurchased and outstanding were as
follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
Shares Net Shares
Shares Issued Repurchased Outstanding
- -------------------------------------------------------------------------------
Balance at
January 1, 2002 555,000,000 -- 555,000,000
Repurchase of
shares (4,383,150) (4,383,150)
Exercise of stock
options 2,000 2,000
- -------------------------------------------------------------------------------
Balance at
December 31, 2002 555,000,000 (4,381,150) 550,618,850
================================================================================
</Table>
In addition, 1.18 billion Class B common shares were issued and outstanding at
December 31, 2002 and 2001. Altria Group, Inc. holds 276.6 million Class A
common shares and all of the Class B common shares at December 31, 2002. There
are no preferred shares issued and outstanding. Class A common shares are
entitled to one vote each, while Class B common shares are entitled to ten votes
each. Therefore, Altria Group, Inc. holds 97.8% of the combined voting power of
the Company's outstanding capital stock at December 31, 2002. At December 31,
2002, 75,911,430 shares of common stock were reserved for stock options and
other stock awards.
Concurrent with the IPO, certain employees of Altria Group, Inc. and its
subsidiaries received a one-time grant of options to purchase shares of the
Company's Class A common stock held by Altria Group, Inc. at the IPO price of
$31.00 per share. In order to completely satisfy this obligation and maintain
its current percentage ownership of the Company, Altria Group, Inc. purchased
1.6 million shares of the Company's Class A common stock in open market
transactions during 2002.
Note 10. Stock Plans:
The Company's Board of Directors adopted the 2001 Kraft Performance Incentive
Plan (the "Plan"), which was established concurrently with the IPO. Under the
Plan, the Company may grant stock options, stock appreciation rights, restricted
stock, reload options and other awards based on the Company's Class A common
stock, as well as performance-based annual and long-term incentive awards. A
maximum of 75 million shares of the Company's Class A common stock may be issued
under the Plan. The Company's Board of Directors granted options for 21,029,777
shares of Class A common stock concurrent with the closing date of the IPO (June
13, 2001) at an exercise price equal to the IPO price of $31.00 per share. A
portion of the shares granted (18,904,637) becomes exercisable on January 31,
2003, and will expire ten years from the date of the grant. The remainder of the
shares granted (2,125,140) may become exercisable on a schedule based on total
shareholder return for the Company's Class A common stock during the three years
following the date of the grant, or will become exercisable five years from the
date of the grant. These options will also expire ten years from the date of the
grant. Shares available to be granted under the Plan at December 31, 2002 were
56,135,543.
The Company's Board of Directors has also adopted the Kraft Director Plan. Under
the Kraft Director Plan, awards are granted only to members of the Board of
Directors who are not full-time employees of the Company or Altria Group, Inc.,
or their subsidiaries. Up to 500,000 shares of Class A common stock may be
awarded under the Kraft Director Plan. During 2002 and 2001, 6,840 and 8,945
stock options were granted under the Kraft Director Plan, respectively. Shares
available to be granted under the Kraft Director Plan at December 31, 2002 were
484,215.
The Company accounts for the plans in accordance with the intrinsic value-based
method permitted by SFAS No. 123, "Accounting for Stock-Based Compensation,"
which did not result in compensation cost for stock options.
Option activity was as follows for the years ended December 31, 2001 and 2002:
<Table>
<Caption>
- --------------------------------------------------------------------------------
Shares Subject Weighted Average Options
to Option Exercise Price Exercisable
- --------------------------------------------------------------------------------
Balance at
January 1, 2001 -- $ -- --
Options granted 21,038,722 31.00
Options canceled (268,420) 31.00
- --------------------------------------------------------------------------------
Balance at
December 31, 2001 20,770,302 31.00 --
Options granted 14,030 37.10
Options exercised (2,000) 31.00
Options canceled (1,490,660) 31.00
- --------------------------------------------------------------------------------
Balance at
December 31, 2002 19,291,672 31.00 696,615
================================================================================
</Table>
The following table summarizes the status of the Company's stock options
outstanding and exercisable as of December 31, 2002:
<Table>
<Caption>
Options Outstanding Options Exercisable
------------------------------------ -----------------------
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- --------------------------------------------------------------------------------
$30.54 - $39.51 19,291,672 8 years $31.00 696,615 $31.08
================================================================================
</Table>
Prior to the IPO, certain employees of the Company participated in Altria Group,
Inc.'s stock compensation plans. Altria Group, Inc. does not currently intend to
issue additional Altria Group, Inc. stock compensation to the Company's
employees, except for reloads of previously issued options. Altria Group, Inc.
accounts for its plans in accordance with the intrinsic value-based method
permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," which did
not result in compensation cost for stock options.
54
<Page>
Kraft Foods Inc.
The Company's employees held options to purchase the following number of shares
of Altria Group, Inc. stock: 46,615,162 shares at an average exercise price of
$35.78 per share at December 31, 2002; 57,349,595 shares at an average exercise
price of $34.66 per share at December 31, 2001; and 56,977,329 shares at an
average exercise price of $30.46 per share at December 31, 2000. Of these
amounts, the following were exercisable at each date: 46,231,629 at an average
exercise price of $35.69 per share at December 31, 2002; 44,930,609 at an
average exercise price of $31.95 per share at December 31, 2001; and 38,444,963
at an average exercise price of $34.82 per share at December 31, 2000.
Had compensation cost for stock option awards under the Kraft plans and Altria
Group, Inc. plans been determined by using the fair value at the grant date, the
Company's net earnings and EPS (basic and diluted) would have been $3,316
million and $1.91 for the year ended December 31, 2002, respectively; $1,785
million and $1.11 for the year ended December 31, 2001, respectively; and $1,947
million and $1.34 for the year ended December 31, 2000, respectively. The
foregoing impact of compensation cost was determined using a modified
Black-Scholes methodology and the following assumptions:
<Table>
<Caption>
- --------------------------------------------------------------------------------
Weighted
Risk-Free Average Expected Fair Value
Interest Expected Expected Dividend at Grant
Rate Life Volatility Yield Date
- --------------------------------------------------------------------------------
2002 Kraft 4.27% 5 years 28.72% 1.41% $10.65
2002 Altria Group,Inc. 3.44 5 33.57 4.96 10.02
2001 Kraft 4.81 5 29.70 1.68 9.13
2001 Altria Group,Inc. 4.86 5 33.88 4.78 10.36
2000 Altria Group,Inc. 6.58 5 31.71 9.00 3.19
- --------------------------------------------------------------------------------
</Table>
In addition, certain of the Company's employees held shares of Altria Group,
Inc. restricted stock and rights to receive shares of stock, giving these
employees in most instances all of the rights of shareholders, except that they
may not sell, assign, pledge or otherwise encumber such shares and rights. These
shares and rights are subject to forfeiture if certain employment conditions are
not met. During 2001 and 2000, Altria Group, Inc. granted to certain of the
Company's U.S. employees restricted stock of 279,120 shares and 2,113,570
shares, respectively. Altria Group, Inc. also issued to certain of the Company's
non-U.S. employees rights to receive 31,310 and 683,790 equivalent shares during
2001 and 2000, respectively. At December 31, 2002, restrictions on the stock,
net of forfeitures, lapse as follows: 2003--84,000 shares. The fair value of the
restricted shares and rights at the date of grant is amortized to expense
ratably over the restriction period through a charge from Altria Group, Inc. In
2002, 2001 and 2000, the Company recorded compensation expense related to
restricted stock awards of $4 million, $39 million and $23 million,
respectively.
Note 11. Earnings Per Share:
Basic and diluted EPS were calculated using the following for the years ended
December 31, 2002, 2001 and 2000:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Net earnings $3,394 $1,882 $2,001
- --------------------------------------------------------------------------------
Weighted average shares for
basic EPS 1,734 1,610 1,455
Plus: Incremental shares from
assumed conversions of
stock options 2
- --------------------------------------------------------------------------------
Weighted average shares for
diluted EPS 1,736 1,610 1,455
================================================================================
</Table>
During June 2001, the Company completed an IPO of 280,000,000 shares of its
Class A common stock. Immediately following the IPO, the Company had
1,735,000,000 Class A and B common shares outstanding.
Note 12. Pre-Tax Earnings and Provision for Income Taxes:
Pre-tax earnings and provision for income taxes consisted of the following for
the years ended December 31, 2002, 2001 and 2000:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Pre-tax earnings:
- --------------------------------------------------------------------------------
United States $3,692 $2,282 $2,188
Outside United States 1,575 1,165 1,227
- --------------------------------------------------------------------------------
Total pre-tax earnings $5,267 $3,447 $3,415
================================================================================
Provision for income taxes:
United States federal:
Current $ 825 $ 594 $ 572
Deferred 265 299 218
- --------------------------------------------------------------------------------
1,090 893 790
State and local 138 112 120
- --------------------------------------------------------------------------------
Total United States 1,228 1,005 910
- --------------------------------------------------------------------------------
Outside United States:
Current 628 445 477
Deferred 13 115 27
- --------------------------------------------------------------------------------
Total outside United States 641 560 504
- --------------------------------------------------------------------------------
Total provision for income taxes $1,869 $1,565 $1,414
================================================================================
</Table>
55
<Page>
Kraft Foods Inc.
At December 31, 2002, applicable United States federal income taxes and foreign
withholding taxes have not been provided on approximately $2.4 billion of
accumulated earnings of foreign subsidiaries that are expected to be permanently
reinvested. It is not practical to estimate the amount of additional taxes that
might be payable on such undistributed earnings.
The effective income tax rate on pre-tax earnings differed from the U.S. federal
statutory rate for the following reasons for the years ended December 31, 2002,
2001 and 2000:
<Table>
<Caption>
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
U.S. federal statutory rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
State and local income taxes,
net of federal tax benefit 1.7 2.0 2.2
Goodwill amortization 9.4 5.2
Other (1.2) (1.0) (1.0)
- --------------------------------------------------------------------------------
Effective tax rate 35.5% 45.4% 41.4%
================================================================================
</Table>
The tax effects of temporary differences that gave rise to deferred income tax
assets and liabilities consisted of the following at December 31, 2002 and 2001:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------------
Deferred income tax assets:
Accrued postretirement and
postemployment benefits $ 759 $ 774
Other 519 737
- --------------------------------------------------------------------------------
Total deferred income tax assets 1,278 1,511
- --------------------------------------------------------------------------------
Deferred income tax liabilities:
Trade names (3,839) (3,847)
Property, plant and equipment (1,515) (1,379)
Prepaid pension costs (841) (850)
- --------------------------------------------------------------------------------
Total deferred income tax liabilities (6,195) (6,076)
- --------------------------------------------------------------------------------
Net deferred income tax liabilities $(4,917) $(4,565)
================================================================================
</Table>
Note 13. Segment Reporting:
The Company manufactures and markets packaged retail food products, consisting
principally of beverages, cheese, snacks, convenient meals and various packaged
grocery products through KFNA and KFI. Reportable segments for KFNA are
organized and managed principally by product category. KFNA's segments are
Cheese, Meals and Enhancers; Biscuits, Snacks and Confectionery; Beverages,
Desserts and Cereals; and Oscar Mayer and Pizza. KFNA's food service business
within the United States and its businesses in Canada and Mexico are reported
through the Cheese, Meals and Enhancers segment. KFI's operations are organized
and managed by geographic location. KFI's segments are Europe, Middle East and
Africa; and Latin America and Asia Pacific.
The Company's management reviews operating companies income to evaluate segment
performance and allocate resources. Operating companies income excludes general
corporate expenses and amortization of intangibles. Interest and other
debt expense, net, and provision for income taxes are centrally managed and,
accordingly, such items are not presented by segment since they are excluded
from the measure of segment profitability reviewed by management. The Company's
assets, which are principally in the United States and Europe, are managed
geographically. The accounting policies of the segments are the same as those
described in the Summary of Significant Accounting Policies.
Reportable segment data were as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
For the Years Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Net revenues:
Cheese, Meals and Enhancers $ 8,877 $ 8,732 $ 7,923
Biscuits, Snacks and Confectionery 5,182 5,071 293
Beverages, Desserts and Cereals 4,412 4,237 4,267
Oscar Mayer and Pizza 3,014 2,930 2,829
- --------------------------------------------------------------------------------
Total Kraft Foods North America 21,485 20,970 15,312
- --------------------------------------------------------------------------------
Europe, Middle East and Africa 6,203 5,936 6,398
Latin America and Asia Pacific 2,035 2,328 1,212
- --------------------------------------------------------------------------------
Total Kraft Foods International 8,238 8,264 7,610
- --------------------------------------------------------------------------------
Net revenues $ 29,723 $29,234 $22,922
================================================================================
Operating companies income:
Cheese, Meals and Enhancers $ 2,168 $ 2,099 $ 1,845
Biscuits, Snacks and Confectionery 1,093 966 100
Beverages, Desserts and Cereals 1,136 1,192 1,090
Oscar Mayer and Pizza 556 539 512
- --------------------------------------------------------------------------------
Total Kraft Foods North America 4,953 4,796 3,547
- --------------------------------------------------------------------------------
Europe, Middle East and Africa 962 861 1,019
Latin America and Asia Pacific 368 378 189
- --------------------------------------------------------------------------------
Total Kraft Foods International 1,330 1,239 1,208
- --------------------------------------------------------------------------------
Total operating companies income 6,283 6,035 4,755
Amortization of intangibles (7) (962) (535)
General corporate expenses (162) (189) (208)
- --------------------------------------------------------------------------------
Operating income 6,114 4,884 4,012
Interest and other debt expense, net (847) (1,437) (597)
- --------------------------------------------------------------------------------
Earnings before income taxes and
minority interest $ 5,267 $ 3,447 $ 3,415
================================================================================
</Table>
56
<Page>
Kraft Foods Inc.
As previously noted, the Company's international operations are managed by
geographic location. Within its two geographic regions, KFI's brand portfolio
spans five core consumer sectors. Net revenues by consumer sector for KFI were
as follows:
Consumer Sector
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
For the Years Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Snacks $3,179 $3,077 $2,565
Beverages 2,832 2,900 3,034
Cheese 1,202 1,208 1,193
Grocery 752 826 544
Convenient Meals 273 253 274
- --------------------------------------------------------------------------------
Total $8,238 $8,264 $7,610
================================================================================
</Table>
During 2002, the Company sold its Latin American yeast and industrial bakery
ingredients business at a pre-tax gain of $69 million. This pre-tax gain was
included in the operating companies income of the Latin America and Asia Pacific
segment.
In addition, during 2002, the Company recorded a pre-tax charge of $142 million
related to employee acceptances under a voluntary retirement program. During
2002, the Company also recorded pre-tax integration related charges of $115
million to consolidate production lines in North America, close a Kraft facility
and for other consolidation programs. In addition, during 2002, the Company
reversed $4 million related to the loss on sale of a food factory. These items
were included in the operating companies income of the following segments:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Integration costs
Separation and a loss on sale
Programs of a food factory
- --------------------------------------------------------------------------------
Cheese, Meals and Enhancers $ 60 $ 30
Biscuits, Snacks and Confectionery 3 1
Beverages, Desserts and Cereals 47 56
Oscar Mayer and Pizza 25 7
Europe, Middle East and Africa 5
Latin America and Asia Pacific 2 17
- --------------------------------------------------------------------------------
$142 $111
================================================================================
</Table>
During 2001, the Company recorded pre-tax charges of $53 million for site
reconfigurations and other consolidation programs in the United States. In
addition, the Company recorded a pre-tax charge of $29 million to close a North
American food factory. These pre-tax charges, which aggregate $82 million, were
included in the operating companies income of the following segments: Cheese,
Meals and Enhancers, $63 million; Biscuits, Snacks and Confectionery, $2
million; Beverages, Desserts and Cereals, $12 million; and Oscar Mayer and
Pizza, $5 million.
See Notes 4 and 5 regarding divestitures and acquisitions. The acquisition of
Nabisco primarily affected the reported results of the Biscuits, Snacks and
Confectionery and the Latin America and Asia Pacific segments.
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
For the Years Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Depreciation expense:
Cheese, Meals and Enhancers $ 177 $ 163 $150
Biscuits, Snacks and Confectionery 156 152
Beverages, Desserts and Cereals 115 113 109
Oscar Mayer and Pizza 58 55 51
- --------------------------------------------------------------------------------
Total Kraft Foods North America 506 483 310
- --------------------------------------------------------------------------------
Europe, Middle East and Africa 167 158 163
Latin America and Asia Pacific 36 39 26
- --------------------------------------------------------------------------------
Total Kraft Foods International 203 197 189
- --------------------------------------------------------------------------------
Total depreciation expense $ 709 $ 680 $499
================================================================================
Capital expenditures:
Cheese, Meals and Enhancers $ 249 $ 257 $247
Biscuits, Snacks and Confectionery 232 171
Beverages, Desserts and Cereals 194 202 193
Oscar Mayer and Pizza 133 131 148
- --------------------------------------------------------------------------------
Total Kraft Foods North America 808 761 588
- --------------------------------------------------------------------------------
Europe, Middle East and Africa 265 231 239
Latin America and Asia Pacific 111 109 79
- --------------------------------------------------------------------------------
Total Kraft Foods International 376 340 318
- --------------------------------------------------------------------------------
Total capital expenditures $1,184 $1,101 $906
================================================================================
</Table>
Geographic data for net revenues, total assets and long-lived assets (which
consist of all non-current assets, other than goodwill and other intangible
assets and prepaid pension assets) were as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
For the Years Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Net revenues:
United States $19,395 $19,193 $13,947
Europe 5,908 5,667 6,222
Other 4,420 4,374 2,753
- --------------------------------------------------------------------------------
Total net revenues $29,723 $29,234 $22,922
================================================================================
Total assets:
United States $44,406 $44,420 $40,454
Europe 8,738 7,362 7,630
Other 3,956 4,016 3,987
- --------------------------------------------------------------------------------
Total assets $57,100 $55,798 $52,071
================================================================================
Long-lived assets:
United States $ 6,382 $ 6,360 $ 6,684
Europe 2,432 2,132 2,116
Other 1,596 1,668 1,912
- --------------------------------------------------------------------------------
Total long-lived assets $10,410 $10,160 $10,712
================================================================================
</Table>
57
<Page>
Kraft Foods Inc.
Note 14. Benefit Plans:
The Company sponsors noncontributory defined benefit pension plans covering
substantially all U.S. employees. Pension coverage for employees of Kraft's
non-U.S. subsidiaries is provided, to the extent deemed appropriate, through
separate plans, many of which are governed by local statutory requirements. In
addition, Kraft's U.S. and Canadian subsidiaries provide health care and other
benefits to substantially all retired employees. Health care benefits for
retirees outside the United States and Canada are generally covered through
local government plans.
PENSION PLANS: Net pension (income) cost consisted of the following for the
years ended December 31, 2002, 2001 and 2000:
<Table>
<Caption>
(In Millions) U.S. Plans Non-U.S. Plans
- --------------------------------------------------------------------------------
2002 2001 2000 2002 2001 2000
- --------------------------------------------------------------------------------
Service cost $ 120 $ 107 $ 69 $ 49 $ 45 $ 37
Interest cost 339 339 213 120 112 98
Expected return on
plan assets (631) (648) (523) (134) (126) (103)
Amortization:
Net gain on adoption
of SFAS No. 87 (11) (1)
Unrecognized net
loss (gain)
from experience
differences 8 (21) (36) 5 (1) (1)
Prior service cost 1 8 7 7 5 4
Other expense (income) 130 (12) (34)
- --------------------------------------------------------------------------------
Net pension
(income) cost $ (33) $(227) $(315) $ 47 $ 35 $ 34
================================================================================
</Table>
During 2002, certain salaried employees in the United States left the Company
under a voluntary early retirement program instituted in 2001. This resulted in
special termination benefits and curtailment and settlement losses of $109
million in 2002. In addition, retiring employees elected lump-sum payments,
resulting in settlement losses of $21 million in 2002 and settlement gains of
$12 million and $34 million in 2001 and 2000, respectively.
The changes in benefit obligations and plan assets, as well as the funded status
of the Company's pension plans at December 31, 2002 and 2001, were as follows:
<Table>
<Caption>
(In Millions) U.S. Plans Non-U.S. Plans
- --------------------------------------------------------------------------------
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Benefit obligation at
January 1 $4,964 $4,327 $2,021 $1,915
Service cost 120 107 49 45
Interest cost 339 339 120 112
Benefits paid (624) (403) (115) (108)
Acquisitions 71 (22)
Settlements 127 14
Actuarial losses 367 500 85 22
Currency 144 18
Other (48) 9 13 39
- --------------------------------------------------------------------------------
Benefit obligation at
December 31 5,245 4,964 2,317 2,021
- --------------------------------------------------------------------------------
Fair value of plan assets at
January 1 6,359 7,039 1,329 1,589
Actual return on plan assets (914) (386) (56) (227)
Contributions 26 37 81 63
Benefits paid (636) (394) (87) (76)
Acquisitions (45) (41)
Currency 70 18
Actuarial gains 130 108 3
- --------------------------------------------------------------------------------
Fair value of plan assets at
December 31 4,965 6,359 1,337 1,329
- --------------------------------------------------------------------------------
(Deficit) excess of plan assets
versus benefit obligations at
December 31 (280) 1,395 (980) (692)
Unrecognized actuarial
losses 2,487 756 394 226
Unrecognized prior
service cost 13 56 50 49
Unrecognized net transition
obligation (1) 7 7
- --------------------------------------------------------------------------------
Net prepaid pension
asset (liability) $2,220 $2,206 $ (529) $ (410)
================================================================================
</Table>
The combined U.S. and non-U.S. pension plans resulted in a net prepaid asset of
$1,691 million and $1,796 million at December 31, 2002 and 2001, respectively.
These amounts were recognized in the Company's consolidated balance sheets at
December 31, 2002 and 2001, as prepaid pension assets of $2,814 million and
$2,675 million, respectively, for those plans in which plan assets exceeded
their accumulated benefit obligations and as other liabilities of $1,123 million
and $879 million at December 31, 2002 and 2001, respectively, for plans in which
the accumulated benefit obligations exceeded their plan assets.
58
<Page>
Kraft Foods Inc.
At December 31, 2002 and 2001, certain of the Company's U.S. plans were
underfunded, with projected benefit obligations, accumulated benefit obligations
and the fair value of plan assets of $269 million, $217 million and $45 million,
respectively, in 2002 and $213 million, $164 million and $15 million,
respectively, in 2001. For certain non-U.S. plans, which have accumulated
benefit obligations in excess of plan assets, the projected benefit obligation,
accumulated benefit obligation and fair value of plan assets were $1,375
million, $1,250 million and $424 million, respectively, as of December 31, 2002
and $1,165 million, $1,073 million and $416 million, respectively, as of
December 31, 2001.
The following weighted-average assumptions were used to determine the Company's
obligations under the plans:
<Table>
<Caption>
U.S. Plans Non-U.S. Plans
- --------------------------------------------------------------------------------
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Discount rate 6.50% 7.00% 5.56% 5.80%
Expected rate of return on
plan assets 9.00 9.00 8.41 8.49
Rate of compensation increase 4.00 4.50 3.12 3.36
- --------------------------------------------------------------------------------
</Table>
SFAS No. 87, "Employers' Accounting for Pensions," permits the delayed
recognition of pension fund gains and losses in ratable periods of up to five
years. The Company uses a four-year period wherein pension fund gains and losses
are reflected in the pension calculation at 25% per year, beginning the year
after the gains or losses occur. Recent stock market declines have resulted in
deferred losses. The amortization of these deferred losses will result in higher
pension cost in future periods.
Kraft and certain of its subsidiaries sponsor employee savings plans, to which
the Company contributes. These plans cover certain salaried, non-union and union
employees. The Company's contributions and costs are determined by the matching
of employee contributions, as defined by the plans. Amounts charged to expense
for defined contribution plans totaled $64 million, $63 million and $43 million
in 2002, 2001 and 2000, respectively.
Postretirement Benefit Plans: Net postretirement health care costs consisted of
the following for the years ended December 31, 2002, 2001 and 2000:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001 2002
- --------------------------------------------------------------------------------
Service cost $ 32 $ 34 $ 23
Interest cost 168 168 109
Amortization:
Unrecognized net loss from
experience differences 21 5 2
Unrecognized prior service cost (20) (8) (8)
Other expense 16
- --------------------------------------------------------------------------------
Net postretirement health
care cost $217 $199 $126
================================================================================
</Table>
During 2002, certain salaried employees in the United States left the Company
under a voluntary early retirement program instituted in 2001. This resulted in
curtailment losses of $16 million, which are included in other expense above.
The Company's postretirement health care plans are not funded. The changes in
the benefit obligations of the plans at December 31, 2002 and 2001 were as
follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------
Accumulated postretirement benefit
obligation at January 1 $2,436 $2,102
Service cost 32 34
Interest cost 168 168
Benefits paid (199) (172)
Curtailments 21
Acquisitions 8
Plan amendments (164) 1
Assumption changes 193 180
Actuarial losses 225 115
- --------------------------------------------------------------------------------
Accumulated postretirement benefit
obligation at December 31 2,712 2,436
Unrecognized actuarial losses (848) (464)
Unrecognized prior service cost 197 53
- --------------------------------------------------------------------------------
Accrued postretirement health care costs $2,061 $2,025
================================================================================
</Table>
The current portion of the Company's accrued postretirement health care costs of
$172 million and $175 million at December 31, 2002 and 2001, respectively, are
included in other accrued liabilities on the consolidated balance sheets.
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation for U.S. plans was 6.8% in 2001, 6.2% in 2002
and 8.0% in 2003, gradually declining to 5.0% by the year 2006 and remaining at
that level thereafter. For Canadian plans, the assumed health care cost trend
rate was 9.0% in 2001, 8.0% in 2002 and 7.0% in 2003, gradually declining to
4.0% by the year 2006 and remaining at that level thereafter.
A one-percentage-point increase in the assumed health care cost trend rates for
each year would increase the accumulated postretirement benefit obligation as of
December 31, 2002, and postretirement health care cost (service cost and
interest cost) for the year then ended by approximately 8.8% and 11.9%,
respectively. A one-percentage-point decrease in the assumed health care cost
trend rates for each year would decrease the accumulated postretirement benefit
obligation as of December 31, 2002, and postretirement health care cost (service
cost and interest cost) for the year then ended by approximately 7.3% and 10.0%,
respectively.
The accumulated postretirement benefit obligations for U.S. plans at December
31, 2002 and 2001 were determined using an assumed discount rate of 6.5% and
7.0%, respectively. The accumulated postretirement benefit obligations for
Canadian plans at December 31, 2002 and 2001 were determined using an assumed
discount rate of 6.75%.
59
<Page>
Kraft Foods Inc.
Assumption changes of $193 million at December 31, 2002 relate primarily to
lowering the discount rate from 7.0% to 6.5% and to increasing the medical trend
rate for the years 2003 through 2005 in consideration of current medical
inflation trends. Assumption changes of $180 million at December 31, 2001 relate
primarily to lowering the discount rate from 7.75% to 7.0%.
Postemployment Benefit Plans: Kraft and certain of its affiliates sponsor
postemployment benefit plans covering substantially all salaried and certain
hourly employees. The cost of these plans is charged to expense over the working
lives of the covered employees. Net postemployment costs consisted of the
following for the years ended December 31, 2002, 2001 and 2000:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Service cost $19 $20 $13
Amortization of unrecognized
net gains (7) (8) (4)
Other expense 23
- --------------------------------------------------------------------------------
Net postemployment costs $35 $12 $ 9
================================================================================
</Table>
During 2002, certain salaried employees in the United States left the Company
under voluntary early retirement and integration programs. These programs
resulted in incremental postemployment costs of $23 million, which are included
in other expense above.
The Company's postemployment plans are not funded. The changes in the benefit
obligations of the plans at December 31, 2002 and 2001 were as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------
Accumulated benefit obligation at January 1 $ 520 $ 373
Service cost 19 20
Benefits paid (141) (156)
Acquisitions 269
Actuarial (gains) losses (103) 14
- --------------------------------------------------------------------------------
Accumulated benefit obligation
at December 31 295 520
Unrecognized experience gains 112 52
- --------------------------------------------------------------------------------
Accrued postemployment costs $ 407 $ 572
================================================================================
</Table>
The accumulated benefit obligation was determined using an assumed ultimate
annual turnover rate of 0.3% in 2002 and 2001, assumed compensation cost
increases of 4.0% in 2002 and 4.5% in 2001, and assumed benefits as defined in
the respective plans. Postemployment costs arising from actions that offer
employees benefits in excess of those specified in the respective plans are
charged to expense when incurred.
Note 15. Additional Information:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
For the Years Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
Research and development
expense $ 360 $ 358 $ 270
- --------------------------------------------------------------------------------
Advertising expense $1,145 $1,190 $1,198
================================================================================
Interest and other debt
expense, net:
Interest expense, Altria Group, Inc.
and affiliates $ 243 $1,103 $ 531
Interest expense, external debt 611 349 84
Interest income (7) (15) (18)
- --------------------------------------------------------------------------------
$ 847 $1,437 $ 597
================================================================================
Rent expense $ 437 $ 372 $ 277
================================================================================
</Table>
Minimum rental commitments under non-cancelable operating leases in effect at
December 31, 2002 were as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
2003 $ 245
2004 197
2005 156
2006 111
2007 95
Thereafter 200
- --------------------------------------------------------------------------------
$1,004
================================================================================
</Table>
Note 16. Financial Instruments:
Derivative Financial Instruments: The Company operates globally, with
manufacturing and sales facilities in various locations around the world, and
utilizes certain financial instruments to manage its foreign currency and
commodity exposures, which primarily relate to forecasted transactions.
Derivative financial instruments are used by the Company, principally to reduce
exposures to market risks resulting from fluctuations in foreign exchange rates
and commodity prices by creating offsetting exposures. The Company is not a
party to leveraged derivatives and, by policy, does not use financial
instruments for speculative purposes. Financial instruments qualifying for hedge
accounting must maintain a specified level of effectiveness between the hedging
instrument and the item being hedged, both at inception and throughout the
hedged period. The Company formally documents the nature of and relationships
between the hedging instruments and hedged items, as well as its risk-management
objectives, strategies for undertaking the various hedge transactions and method
of assessing hedge effectiveness. Additionally, for hedges of forecasted
transactions, the significant characteristics and expected terms of a forecasted
transaction must be specifically identified, and it must be probable that each
forecasted transaction will occur. If it were deemed probable that the
forecasted transaction will not occur, the gain or loss would be recognized in
earnings currently.
60
<Page>
Kraft Foods Inc.
Substantially all of the Company's derivative financial instruments are
effective as hedges under SFAS No. 133. The fair value of all derivative
financial instruments has been calculated based on market quotes.
The Company uses forward foreign exchange contracts and foreign currency options
to mitigate its exposure to changes in foreign currency exchange rates from
third-party and intercompany forecasted transactions. The primary currencies to
which the Company is exposed include the Euro, British pound and Canadian
dollar. At December 31, 2002 and 2001, the Company had option and forward
foreign exchange contracts with aggregate notional amounts of $575 million and
$431 million, respectively, which are comprised of contracts for the purchase
and sale of foreign currencies. The effective portion of unrealized gains and
losses associated with forward contracts is deferred as a component of
accumulated other comprehensive earnings (losses) until the underlying hedged
transactions are reported on the Company's consolidated statement of earnings.
The Company is exposed to price risk related to forecasted purchases of certain
commodities used as raw materials by the Company's businesses. Accordingly, the
Company uses commodity forward contracts, as cash flow hedges, primarily for
coffee, cocoa, milk and cheese. Commodity futures and options are also used to
hedge the price of certain commodities, including milk, coffee, cocoa, wheat,
corn, sugar and soybean oil. In general, commodity forward contracts qualify for
the normal purchase exception under SFAS No. 133 and are, therefore, not subject
to the provisions of SFAS No. 133. At December 31, 2002 and 2001, the Company
had net long commodity positions of $544 million and $589 million, respectively.
Unrealized gains or losses on net commodity positions were immaterial at
December 31, 2002 and 2001. The effective portion of unrealized gains and losses
on commodity futures and option contracts is deferred as a component of
accumulated other comprehensive earnings (losses) and is recognized as a
component of cost of sales in the Company's consolidated statement of earnings
when the related inventory is sold.
Derivative gains or losses reported in accumulated other comprehensive earnings
(losses) are a result of qualifying hedging activity. Transfers of these gains
or losses from accumulated other comprehensive earnings (losses) to earnings are
offset by corresponding gains or losses on the underlying hedged items. During
the years ended December 31, 2002 and 2001, ineffectiveness related to cash flow
hedges was not material. At December 31, 2002, the Company is hedging forecasted
transactions for periods not exceeding fifteen months and expects substantially
all amounts reported in accumulated other comprehensive earnings (losses) to be
reclassified to the consolidated statement of earnings within the next twelve
months.
Hedging activity affected accumulated other comprehensive earnings (losses), net
of income taxes, during the years ended December 31, 2002 and 2001, as follows:
<Table>
<Caption>
(in millions)
- --------------------------------------------------------------------------------
Balance as of January 1, 2001 $ --
Derivative losses transferred to earnings 15
Change in fair value (33)
- --------------------------------------------------------------------------------
Balance as of December 31, 2001 (18)
Derivative losses transferred to earnings 21
Change in fair value 10
- --------------------------------------------------------------------------------
Balance as of December 31, 2002 $ 13
================================================================================
</Table>
Credit Exposure and Credit Risk: The Company is exposed to credit loss in the
event of nonperformance by counterparties. However, the Company does not
anticipate nonperformance, and such exposure was not material at December 31,
2002.
Fair Value: The aggregate fair value, based on market quotes, of the Company's
third-party debt at December 31, 2002 was $11,764 million as compared with its
carrying value of $10,988 million. The aggregate fair value of the Company's
third-party debt at December 31, 2001 was $9,360 million as compared with its
carrying value of $9,355 million. Based on interest rates available to the
Company for issuances of debt with similar terms and remaining maturities, the
aggregate fair value and carrying value of the Company's long-term notes payable
to Altria Group, Inc. and its affiliates were $2,764 million and $2,560 million,
respectively, at December 31, 2002 and $5,325 million and $5,000 million,
respectively, at December 31, 2001.
See Notes 3, 7 and 8 for additional disclosures of fair value for short-term
borrowings and long-term debt.
Note 17. Contingencies:
The Company and its subsidiaries are parties to a variety of legal proceedings
arising out of the normal course of business, including a few cases in which
substantial amounts of damages are sought. While the results of litigation
cannot be predicted with certainty, management believes that the final outcome
of these proceedings will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
Guarantees: At December 31, 2002, the Company's third-party guarantees, which
are primarily derived from acquisition and divestiture activities, approximated
$36 million. Substantially all of these guarantees expire through 2012, with $12
million expiring in 2003. The Company is required to perform under these
guarantees in the event that a third-party fails to make contractual payments or
achieve performance measures. The Company has recorded a liability of $21
million at December 31, 2002 relating to these guarantees.
61
<Page>
Kraft Foods Inc.
Note 18. Quarterly Financial Data (Unaudited):
<Table>
<Caption>
(in millions, except per share data) 2002 Quarters
- --------------------------------------------------------------------------------
First Second Third Fourth
- --------------------------------------------------------------------------------
Net revenues $7,147 $ 7,513 $ 7,216 $7,847
- --------------------------------------------------------------------------------
Gross profit $2,864 $ 3,127 $ 2,971 $3,041
- --------------------------------------------------------------------------------
Net earnings $ 693 $ 901 $ 869 931
- --------------------------------------------------------------------------------
Weighted average
shares for
diluted EPS 1,737 1,738 1,737 1,734
- --------------------------------------------------------------------------------
Per share data:
Basic EPS $ 0.40 $ 0.52 $ 0.50 $ 0.54
- --------------------------------------------------------------------------------
Diluted EPS $ 0.40 $ 0.52 $ 0.50 $ 0.54
- --------------------------------------------------------------------------------
Dividends declared $ 0.13 $ 0.13 $ 0.15 $ 0.15
- --------------------------------------------------------------------------------
Market price--high $39.70 $ 43.95 $ 41.70 $41.30
--low $32.50 $ 38.32 $ 33.87 $36.12
- --------------------------------------------------------------------------------
(in millions, except per share data) 2001 Quarters
- --------------------------------------------------------------------------------
First Second Third Fourth
- --------------------------------------------------------------------------------
Net revenues $7,197 $ 7,473 $ 7,018 $7,546
- --------------------------------------------------------------------------------
Gross profit $2,922 $ 3,071 $ 2,785 $2,890
- --------------------------------------------------------------------------------
Net earnings $ 326 $ 505 $ 503 $ 548
- --------------------------------------------------------------------------------
Weighted average shares
for diluted EPS 1,455 1,510 1,735 1,736
- --------------------------------------------------------------------------------
Per share data:
Basic EPS $ 0.22 $ 0.33 $ 0.29 $ 0.32
- --------------------------------------------------------------------------------
Diluted EPS $ 0.22 $ 0.33 $ 0.29 $ 0.32
- --------------------------------------------------------------------------------
Dividends declared $ 0.13 $ 0.13
- --------------------------------------------------------------------------------
Market price--high $ 32.00 $ 34.81 $35.57
--low $ 29.50 $ 30.00 $31.50
- --------------------------------------------------------------------------------
</Table>
Basic and diluted EPS are computed independently for each of the periods
presented. Accordingly, the sum of the quarterly EPS amounts may not agree to
the total year.
During the first quarter of 2002, the Company recorded a pre-tax charge of $142
million related to employee acceptances of a voluntary retirement program and a
pretax integration related charge of $27 million to consolidate production lines
in North America.
During the second quarter of 2002, the Company recorded a pre-tax integration
related charge of $92 million to close a facility and for other consolidation
programs. Also, during the second quarter of 2002, the Company sold a small
business at a pre-tax gain of $3 million.
During the fourth quarter of 2002, the Company sold two small businesses at an
aggregate pre-tax gain of $77 million. Also, during the fourth quarter of 2002,
the Company reversed $4 million of previously recorded integration related
liabilities and $4 million related to the loss on sale of a food factory to the
consolidated statement of earnings.
During the first quarter of 2001, the Company recorded a pre-tax loss of $29
million for the sale of a North American food factory.
On June 13, 2001, the Company completed an IPO by issuing 280 million shares of
its Class A common stock. Also, during the second quarter of 2001, the Company
sold a small business at a pre-tax gain of $8 million.
During the third quarter of 2001, the Company recorded a pre-tax integration
related charge of $37 million to consolidate production lines in the United
States.
During the fourth quarter of 2001, the Company recorded a pre-tax integration
related charge of $16 million for site reconfigurations and other consolidation
programs in the United States.
62
<Page>
Kraft Foods Inc.
Report of Independent Accountants
To the Board of Directors and Shareholders of Kraft Foods Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, shareholders' equity and cash flows present
fairly, in all material respects, the consolidated financial position of Kraft
Foods Inc. and its subsidiaries (the "Company") at December 31, 2002 and 2001,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, on January 1,
2002, the Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets."
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
January 27, 2003
Company Report on Financial Statements
The consolidated financial statements and all related financial information
herein are the responsibility of the Company. The financial statements, which
include amounts based on judgments, have been prepared in accordance with
generally accepted accounting principles. Other financial information in the
annual report is consistent with that in the financial statements.
The Company maintains a system of internal controls that it believes provides
reasonable assurance that transactions are executed in accordance with
management's authorization and properly recorded, that assets are
safeguarded, and that accountability for assets is maintained. The system of
internal controls is characterized by a control-oriented environment within
the Company, which includes written policies and procedures, careful
selection and training of personnel, and audits by a professional staff of
internal auditors.
PricewaterhouseCoopers LLP, independent accountants, have audited and reported
on the Company's consolidated financial statements. Their audits were performed
in accordance with generally accepted auditing standards.
The Audit Committee of the Board of Directors, composed of four non-employee
directors, meets periodically with PricewaterhouseCoopers LLP, the Company's
internal auditors and management representatives to review internal accounting
control, auditing and financial reporting matters. Both PricewaterhouseCoopers
LLP and the internal auditors have unrestricted access to the Audit Committee
and may meet with it without management representatives being present.
63