Kraft Heinz Company — Q2 2020 Form 10-Q Summary
Business context and reporting period
The filing covers the three and six months ended June 27, 2020, compared with June 29, 2019. Kraft Heinz manufactures and markets packaged food and beverage products globally. Its reportable segments are United States, International, and Canada; prior periods were recast for the 2020 segment reorganization.
COVID-19 increased retail demand but materially reduced foodservice demand. The company also completed a five-year operating plan and recorded significant goodwill and brand impairments.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $6.648 billion | $6.406 billion | $12.805 billion | $12.365 billion |
| Organic net sales | $6.737 billion | $6.272 billion | $12.950 billion | $12.120 billion |
| Operating income/(loss) | $(1.339) billion | $734 million | $(569) million | $1.296 billion |
| Net income/(loss) attributable to common shareholders | $(1.651) billion | $449 million | $(1.273) billion | $854 million |
| Diluted EPS | $(1.35) | $0.37 | $(1.04) | $0.70 |
| Adjusted EBITDA | $1.799 billion | $1.600 billion | $3.214 billion | $3.031 billion |
| Adjusted EPS | $0.80 | $0.78 | $1.39 | $1.44 |
| Operating cash flow | Not separately provided | Not separately provided | $2.216 billion | $1.325 billion |
Reported net sales increased 3.8% in Q2 and 3.6% year to date. Organic net sales increased 7.4% and 6.9%, respectively, driven by favorable volume/mix and pricing. Approximate gross margin was 36.9% in Q2 2020 versus 32.5% in Q2 2019, and 33.7% year to date versus 33.1%. Adjusted EBITDA margin was approximately 27.1% in Q2 versus 25.0%, and 25.1% year to date versus 24.5%.
- United States Q2 sales increased 8.5% and Segment Adjusted EBITDA increased 17.6%; year-to-date sales increased 7.5% and EBITDA increased 12.2%.
- International Q2 sales decreased 0.7% on currency effects, while organic sales increased 5.5%; Segment Adjusted EBITDA increased 3.2%.
- Canada Q2 reported sales decreased 23.9%, primarily from divestitures and currency; organic sales increased 2.0%, but Segment Adjusted EBITDA declined 23.2%.
Cash flow, debt, and liquidity
- Cash and cash equivalents were $2.812 billion at June 27, 2020, compared with $2.279 billion at December 28, 2019. Cash, cash equivalents, and restricted cash increased by $533 million to $2.813 billion.
- Operating cash flow was $2.216 billion, capital expenditures were $258 million, and cash dividends paid were $977 million during the first six months.
- Total debt had a carrying value of approximately $28.9 billion and a fair value of $30.3 billion at June 27, 2020. Long-term debt, including the current portion, declined from $29.2 billion at year-end 2019.
- The company issued $3.5 billion of senior notes due 2027, 2031, and 2050, completed a tender offer, redeemed approximately $1.3 billion of notes, and repaid $405 million of notes at maturity. It also repaid a $4.0 billion revolving-credit draw during Q2.
- No commercial paper or revolving-facility borrowings were outstanding at quarter-end. Management stated that operating cash flow and the $4.0 billion Senior Credit Facility should provide sufficient liquidity for the next 12 months.
- The company expects 2020 capital expenditures of approximately $750 million, subject to change because of COVID-19. A quarterly dividend of $0.40 per share was declared on July 30, 2020.
Material changes versus the prior comparable period
- Q2 operating results moved from $734 million of income to a $1.339 billion loss, primarily because of $2.873 billion of non-cash impairment losses versus $598 million in the prior-year quarter.
- Year-to-date goodwill impairment losses increased to $2.043 billion from $744 million, while intangible-asset impairment losses increased to $1.056 billion from $474 million.
- The company recorded Q2 impairment charges of approximately $1.8 billion on goodwill and $1.1 billion on brands. Affected assets included U.S. Foodservice, Canada Retail, Canada Foodservice, EMEA East, Oscar Mayer, Maxwell House, Velveeta, Cool Whip, Plasmon, ABC, Classico, Wattie’s, and Planters.
- Interest expense increased to $442 million in Q2 and $752 million year to date, including $109 million of debt extinguishment costs and interest associated with the temporary revolver draw.
- Adjusted EBITDA improved despite the reported loss, but year-to-date Adjusted EPS declined 3.5% to $1.39 because of higher taxes on adjusted earnings, unfavorable other expense/income, and higher equity compensation.
- Operating cash flow increased by $891 million year to date, helped by higher Adjusted EBITDA, reduced inventory-related cash usage, lower promotional activity, delayed tax payments, and lower employee bonus payments.
Guidance, outlook, risks, and unusual items
- Management expects continued weakness in away-from-home establishments and foodservice demand beyond Q2 2020. Retail demand benefited from the pandemic, but management cautioned that this benefit could reverse.
- COVID-19 assumptions were incorporated into impairment forecasts and the five-year operating plan. Further deterioration in consumer behavior, restaurant activity, government restrictions, margins, foreign exchange rates, or discount rates could cause additional impairments.
- Approximately $30.4 billion of goodwill was associated with reporting units having 10% or less excess fair value over carrying amount at the annual impairment test date. Certain brands also had minimal valuation cushion.
- The company faces risks from supply-chain disruption, manufacturing or workforce interruptions, commodity inflation, foreign exchange volatility, customer and supplier stress, private-label competition, and changes in consumer purchasing patterns.
- The SEC and the U.S. Attorney’s Office for the Northern District of Illinois continue reviewing procurement, financial reporting, internal controls, impairment assessments, disclosures, and related matters. The company cannot predict the scope, duration, or outcome.
- The company is defending securities, ERISA, and shareholder derivative litigation. Because proceedings are at an early stage, potential losses cannot reasonably be estimated.
- Fitch and S&P downgraded the company’s long-term credit rating to BB+ in February 2020. The company stated that the downgrades did not trigger defaults and did not limit access to the revolving facility.
- Management concluded that the previously reported material weakness in risk assessment had been remediated as of June 27, 2020, and that disclosure controls were effective.
Most important facts for investors to verify
- Whether retail demand remains elevated after pandemic-related pantry loading and whether foodservice recovery offsets any normalization.
- Updated performance and valuation assumptions for foodservice, Canada, and vulnerable brands, including the risk of additional non-cash impairments.
- Debt maturities, refinancing costs, rating-agency actions, covenant compliance, and the company’s ability to sustain dividends while reducing leverage.
- Status and potential financial impact of the SEC and U.S. Attorney’s Office reviews and related shareholder litigation.
- Cash-flow quality, including the effects of supplier payment programs, delayed tax payments, derivative collateral, working-capital movements, and future capital expenditures.
- Whether management’s remediation of the material weakness remains effective under continuing COVID-19 operating conditions.