Kraft Heinz Company — Q1 2019 Form 10-Q Summary
Business context and reporting period
The filing covers the three months ended March 30, 2019. Kraft Heinz manufactures and markets food and beverage products globally through its United States, Canada, EMEA, and Rest of World segments. Comparative first-quarter 2018 information has been restated for procurement-related accounting errors, lease classifications, tax items, impairments, and other misstatements.
Key financial metrics
| Metric | Q1 2019 | Q1 2018, restated | Change |
|---|---|---|---|
| Net sales | $5,959 million | $6,304 million | (5.5%) |
| Organic net sales | $6,022 million | $6,197 million | (2.8%) |
| Gross profit | $2,011 million | $2,264 million | (11.2%) |
| Gross margin | 33.7% | 35.9% | Down 220 basis points |
| Operating income | $562 million | $1,500 million | (62.5%) |
| Operating margin | 9.4% | 23.8% | Down 1,440 basis points |
| Net income attributable to common shareholders | $405 million | $1,003 million | (59.6%) |
| Diluted EPS | $0.33 | $0.82 | (59.8%) |
| Adjusted EBITDA | $1,431 million | $1,807 million | (20.8%) |
| Adjusted EPS | $0.66 | $0.90 | (26.7%) |
| Operating cash flow | $304 million | $408 million | (25.5%) |
Organic net sales declined primarily because of lower pricing, down 2.4 percentage points, and unfavorable volume/mix, down 0.4 percentage points. Reported sales also reflected unfavorable foreign currency effects of 2.4 percentage points and acquisition and divestiture effects of 0.3 percentage points.
- United States sales declined 3.8% and Segment Adjusted EBITDA declined 18.6%.
- Canada sales declined 7.0% and Segment Adjusted EBITDA declined 10.3%.
- EMEA sales declined 11.5% and Segment Adjusted EBITDA declined 21.4%.
- Rest of World sales declined 8.7%, although organic sales increased 3.4%; Segment Adjusted EBITDA declined 29.4%, primarily due to currency and the Heinz India divestiture.
Cash flow, debt, liquidity, and balance sheet
- Cash, cash equivalents, and restricted cash totaled $1,102 million at March 30, 2019, compared with $1,136 million at December 29, 2018. Cash and cash equivalents were $1,096 million.
- Operating cash flow was $304 million. Investing activities provided $177 million, including $640 million of net proceeds from the Heinz India sale, partially offset by $249 million of capital expenditures and $200 million paid for Primal Nutrition. Financing activities used $504 million, including $488 million of dividends.
- Long-term debt, including the current portion, was approximately $31.1 billion. Total debt carrying value was approximately $31.1 billion and estimated fair value was $30.8 billion.
- No commercial paper or Senior Credit Facility borrowings were outstanding at quarter-end. The Senior Credit Facility provides $4.0 billion of revolving capacity, subject to conditions.
- The company stated that cash generation, commercial paper capacity, the revolving facility, and capital-market access were expected to provide sufficient liquidity. Approximately $900 million of senior notes mature in February 2020, followed by approximately C$800 million and $1.5 billion in July 2020.
- Inventory increased to $3,118 million from $2,667 million, while assets held for sale declined to $1,026 million from $1,376 million, primarily after the Heinz India closing.
Material changes, unusual items, and outlook
- The company recorded a $620 million non-cash goodwill impairment charge related to reporting units in EMEA East, Brazil, and Latin America Exports. Management also disclosed subsequent second-quarter 2019 impairment charges of $118 million for U.S. Refrigerated goodwill and $474 million for six U.S. brands.
- Kraft Heinz completed the $655 million Heinz India divestiture on January 30, 2019, recognizing a $246 million pretax gain. It acquired Primal Nutrition for $202 million on January 3, 2019.
- The company expected to complete the $1.2 billion Canada Natural Cheese divestiture on July 2, 2019 and expected to recognize a gain in the third quarter.
- Restructuring expenses were $27 million, compared with $90 million in the prior-year quarter. Approximately 400 positions were expected to be eliminated, including 100 eliminated during the quarter.
- Management expected 2019 capital expenditures of approximately $800 million. The filing does not provide a clear consolidated full-year revenue or earnings guidance figure.
- The company adopted the new lease standard, recognizing $821 million of lease assets and $887 million of lease liabilities at adoption, without an opening retained-earnings adjustment.
Risks, contingencies, and controls
- The SEC and the U.S. Attorney’s Office for the Northern District of Illinois were reviewing procurement-related accounting, internal controls, impairment assessments, financial reporting, and disclosures. The company could not predict the scope, duration, outcome, or potential financial impact.
- The company restated prior-period financial statements after identifying procurement misconduct and errors in the timing of supplier rebates, incentives, pricing arrangements, and embedded leases. The identified procurement-related cost-of-products-sold misstatements totaled $208 million across prior periods.
- Management concluded that disclosure controls and procedures were ineffective as of March 30, 2019 because of material weaknesses in risk assessment, supplier-contract accounting, and goodwill and indefinite-lived intangible-asset impairment testing. Remediation was in progress, with remaining improvements targeted for early 2020.
- The company faced securities class actions, an ERISA class action, and shareholder derivative litigation related to alleged misleading disclosures, internal controls, procurement practices, and investment in company stock. Potential losses could not reasonably be estimated.
- Additional impairment risk remained significant. Reporting units with 10% or less excess fair value had approximately $33.0 billion of goodwill, and brands with 10% or less excess fair value had approximately $26.4 billion of carrying value after impairment.
- Venezuela remained subject to hyperinflationary accounting, currency controls, economic deterioration, and potential restrictions affecting operations or consolidation.
- Because of delayed filings, the company temporarily failed to meet certain reporting covenants under its credit facility and indentures but obtained waivers. Filing the Form 10-Q was intended to restore compliance with those reporting requirements.
Facts investors should verify
- Progress and final results of the SEC and related governmental investigations, litigation, and internal-control remediation.
- Whether the disclosed second-quarter impairment charges and future impairment risks lead to additional write-downs.
- Organic sales, pricing, volume/mix, and margin trends, particularly in the United States and EMEA.
- Ability to refinance or repay the 2020 debt maturities while maintaining dividends and planned capital expenditures.
- Completion economics and use of proceeds from the Canada Natural Cheese divestiture.
- Whether the restated financial information and material weaknesses affect investor confidence, access to capital markets, or employee equity-plan administration.