Kraft 2005 Annual Report Download - page 14

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MERRILL CORPORATION MBLOUNT// 9-MAR-06 14:03 DISK126:[06CHI5.06CHI1135]DE1135A.;25
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DISK024:[PAGER.PSTYLES]UNIVERSAL.BST;51
KRAFT FOODS-FSC CERTIFIED-10K/AR Proj: P1102CHI06 Job: 06CHI1135 File: DE1135A.;25
Merrill Corporation/Chicago (312) 786-6300 Page Dim: 8.250X 10.750Copy Dim: 38. X 54.3
Company’s products for their private label products. If the Company fails to respond to these trends, its
volume growth could slow or it may need to lower prices or increase promotional spending for its
products, any of which would adversely affect its profitability.
Commodity price increases will increase operating costs and may reduce profitability.
The Company is a major purchaser of milk, cheese, plastic, nuts, green coffee beans, cocoa, corn
products, wheat, rice, pork, poultry, beef, vegetable oil, sugar, other sweeteners and numerous other
commodities. Commodities such as these often experience price volatility caused by conditions outside
of the Company’s control, including fluctuations in commodities markets, currency fluctuations and
changes in governmental agricultural programs. Commodity prices impact the Company’s business
directly through the cost of raw materials used to make the Company’s products (such as cheese), the
cost of inputs used to manufacture and ship the Company’s products (such as oil and energy) and the
amount the Company pays to produce or purchase packaging for its products (such as cardboard and
plastic). For 2005, pre-tax aggregate commodity costs increased by approximately $800 million versus
2004, following an increase of approximately $900 million for 2004 compared with 2003. If, as a result of
consumer sensitivity to pricing or otherwise, the Company is unable to increase its prices to offset
increased commodities costs, the Company may experience lower profitability.
Sales of the Company’s products are subject to changing consumer preferences, and the
Company’s success depends upon its ability to predict, identify and interpret changes in
consumer preferences and develop and offer new products rapidly enough to meet those
changes.
The Company’s success depends on its ability to predict, identify and interpret the tastes and
dietary habits of consumers and to offer products that appeal to those preferences. Consumer
preferences for food products are ever-changing. For example, recently, consumers have been
increasingly focused on health and wellness with respect to the food products they buy. As a result, the
Company’s products have been subject to scrutiny relating to genetically modified organisms and the
health implications of obesity and trans-fatty acids. The Company has been and will continue to be
impacted by publicity concerning the health implications of its products, which could negatively
influence consumer perception and acceptance of the Company’s products and marketing programs.
Furthermore, if the Company does not succeed in offering products that consumers want to buy, the
Company’s sales and market share will decrease, resulting in reduced profitability. A significant
challenge for the Company is distinguishing among fads, mid-term trends and lasting changes in the
Company’s consumer environment. If the Company is unable to accurately predict which shifts in
consumer preferences will be long-lasting, or to introduce new and improved products to satisfy those
preferences, its sales will decline. In addition, given the variety of backgrounds and identities of
consumers in the Company’s consumer base, the Company must offer a sufficient array of products to
satisfy the broad spectrum of consumer preferences. As such, the Company must be successful in
developing innovative products across a multitude of product categories. Finally, if the Company fails to
rapidly develop products in faster growing and more profitable categories, the Company could
experience reduced demand for its products.
The Company’s foreign operations are subject to additional risks.
The Company operates its business and markets its products internationally. In 2005 and 2004,
38% of the Company’s sales were generated in foreign countries. The Company’s foreign operations are
subject to the risks described in this section, as well as risks related to fluctuations in currency values,
foreign currency exchange controls, discriminatory fiscal policies, compliance with foreign laws,
enforcement of remedies in foreign jurisdictions and other economic or political uncertainties. In
particular, the Company’s subsidiaries conduct their businesses in local currency and, for purposes of
financial reporting, their results are translated into U.S. dollars based on average exchange rates
13
6 C Cs: 38506