Kraft Heinz Co. — Q1 2020 Form 10-Q Summary
Business context and reporting period
The Kraft Heinz Company manufactures and markets food and beverage products globally, including condiments and sauces, cheese and dairy, meals, meats, beverages, coffee, and grocery products. The filing covers the three months ended March 28, 2020, compared with the three months ended March 30, 2019. Reporting segments were reorganized into United States, International, and Canada, with historical periods recast accordingly.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $6,157 million | $5,959 million | 3.3% |
| Organic net sales | $6,213 million | $5,848 million | 6.2% |
| Gross profit | $1,858 million | $2,011 million | Gross margin 30.2% vs. 33.7% |
| Operating income | $770 million | $562 million | Operating margin 12.5% vs. 9.4% |
| Net income attributable to common shareholders | $378 million | $405 million | (6.7%) |
| Diluted EPS | $0.31 | $0.33 | (6.1%) |
| Adjusted EBITDA | $1,415 million | $1,431 million | (1.1%) |
| Adjusted EPS | $0.58 | $0.66 | (12.1%) |
| Operating cash flow | $212 million | $304 million | $(92) million |
Organic sales growth reflected favorable volume/mix of 4.6 percentage points and pricing of 1.6 percentage points. Management estimated that COVID-19-related demand contributed approximately 6 to 7 percentage points to organic sales growth. Retail demand increased, particularly in March, while foodservice demand declined.
- United States net sales increased 6.4% to $4,495 million; Segment Adjusted EBITDA increased 6.2% to $1,209 million.
- International net sales increased 1.3% to $1,301 million; organic net sales increased 6.9% and Segment Adjusted EBITDA increased 2.5% to $245 million.
- Canada net sales decreased 19.8% to $361 million, primarily because of divestitures and foreign exchange; organic net sales increased 2.2%, but Segment Adjusted EBITDA fell 54.0% to $55 million.
Liquidity, cash flow, debt, and capital allocation
- Cash and cash equivalents were $5.403 billion at March 28, 2020, compared with $2.279 billion at December 28, 2019.
- The increase in cash primarily resulted from a $4.0 billion draw on the senior unsecured revolving credit facility as a precautionary measure during the COVID-19-related market uncertainty.
- Total debt, including current maturities, was approximately $32.8 billion, up from $29.2 billion at year-end 2019. The revolving facility carried an interest rate of LIBOR plus 125 basis points.
- Operating cash flow was $212 million. Investing cash flow was negative $122 million, including $131 million of capital expenditures. Financing cash flow was positive $3.105 billion, primarily reflecting the revolver draw, partially offset by $407 million of debt repayments and $488 million of dividends.
- The company had no commercial paper outstanding and was restricted from issuing commercial paper while the revolving facility was fully drawn.
- Management expected 2020 capital expenditures of approximately $750 million, subject to change because of COVID-19, and stated that available cash and operating cash flow should cover expected needs for the next 12 months.
- The company paid $0.40 per share in quarterly dividends during the period. On April 30, 2020, the board declared another $0.40 per share dividend payable June 26, 2020.
Material changes versus the prior comparable period
- Sales benefited from pandemic-related retail stock-up demand, but gross margin declined because of higher supply chain costs, commodity costs, unfavorable mix, and unrealized commodity hedge losses.
- Operating income increased because goodwill impairment losses declined to $226 million from $620 million in the prior-year quarter. The current-year impairment related to International reporting units.
- Net income and EPS declined despite higher operating income because other income decreased to $81 million from $380 million. The prior period included a $246 million gain on the Heinz India divestiture; the current period included a $2 million net loss on business sales.
- Unrealized losses on commodity hedges were $143 million, compared with a $29 million gain in the prior-year period.
- Other comprehensive loss was $554 million, primarily reflecting foreign currency translation losses, compared with other comprehensive income of $135 million in Q1 2019.
- The company recorded a $3 million estimated loss related to a potential International business disposition and had two International businesses classified as held for sale.
Outlook, commentary, risks, and unusual items
Management did not provide a formal full-year sales or earnings forecast in the filing. It expected continued weakness in away-from-home establishments and foodservice during 2020, while noting that the duration and ultimate financial effects of COVID-19 remained uncertain. The company expected to hold the $4.0 billion revolver draw for less than 12 months.
- COVID-19 may disrupt manufacturing, labor availability, suppliers, distributors, customer demand, working capital, commodity costs, foreign exchange, financing access, and internal controls.
- Foodservice reporting units in the United States and Canada had approximately $4.3 billion of aggregate goodwill and less than 10% excess fair value over carrying amount at their latest impairment testing date. Management concluded that no interim triggering event existed as of March 28, 2020, but future impairments remain possible.
- The company’s goodwill balance was $35.1 billion and indefinite-lived intangible assets were $43.1 billion. Management was conducting an enterprise strategy review and expected to update its five-year operating plan in 2020, potentially affecting impairment assessments and divestiture plans.
- Fitch and S&P downgraded the company’s long-term credit rating from BBB- to BB+ in February 2020. The downgrades could increase borrowing costs and reduce commercial paper access.
- A material weakness in risk assessment controls over financial reporting remained unremediated as of March 28, 2020. Management stated that the previously reported material weakness involving supplier contracts and related arrangements had been remediated.
- The company disclosed securities class actions, derivative actions, an ERISA action, and continuing SEC and U.S. Attorney investigations. The potential loss from the litigation and investigations could not reasonably be estimated.
Important facts for investors to verify
- Whether pandemic-driven retail volume persists or reverses as consumer purchasing patterns normalize.
- The duration and magnitude of foodservice weakness and its effect on the U.S. and Canada foodservice reporting units.
- Potential future goodwill and brand impairments under updated operating plans, discount rates, growth assumptions, and COVID-19 scenarios.
- Debt maturities of approximately C$500 million and $200 million in July 2020 and approximately $650 million in February 2021, as well as the timing of repayment of the $4.0 billion revolver draw.
- Whether operating cash flow improves from the Q1 level and supports capital expenditures, dividends, debt repayments, and working-capital requirements.
- Developments in the SEC and U.S. Attorney investigations, related securities and derivative litigation, and any resulting financial or control consequences.
- Progress toward remediation of the remaining material weakness in risk assessment controls.