Kraft Heinz Company: FY2019 Form 10-K Summary
Business context and reporting period
Kraft Heinz is a global food and beverage company with approximately $25 billion of annual sales, approximately 37,000 employees, and four reported segments: United States, Canada, EMEA, and Rest of World. The filing covers the 52-week fiscal year ended December 28, 2019. The fourth quarter ended December 28, 2019 and is separately presented in unaudited quarterly data.
Beginning in the first quarter of 2020, management planned to combine EMEA, Latin America, and APAC into an International segment and move Puerto Rico into the United States segment.
Financial performance and key metrics
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Net sales | $24.977 billion | $26.268 billion | (4.9%) |
| Organic net sales | $24.961 billion | $25.393 billion | (1.7%) |
| Gross profit | $8.147 billion | $8.921 billion | (8.7%) |
| Operating income/(loss) | $3.070 billion | $(10.205) billion | Improved |
| Net income attributable to common shareholders | $1.935 billion | $(10.192) billion | Improved |
| Diluted EPS | $1.58 | $(8.36) | Improved |
| Adjusted EBITDA | $6.064 billion | $7.024 billion | (13.7%) |
| Adjusted EPS | $2.85 | $3.51 | (18.8%) |
Approximate FY2019 margins were 32.6% gross, 12.3% operating, 7.7% net income attributable to common shareholders, and 24.3% adjusted EBITDA. Reported profitability benefited substantially from lower impairment charges, while underlying adjusted performance weakened.
- Net sales declined primarily from unfavorable foreign currency effects of 1.9 percentage points, acquisitions and divestitures of 1.3 points, and unfavorable volume/mix of 1.8 points; pricing contributed 0.1 point.
- Goodwill and intangible-asset impairment losses totaled $1.899 billion in 2019 versus $15.936 billion in 2018, including $1.197 billion of goodwill impairment and $702 million of intangible-asset impairment in 2019.
- Operating cash flow was $3.552 billion, compared with $2.574 billion in 2018. Investing cash flow was $1.511 billion, including $1.875 billion of proceeds from business sales. Financing cash flow was $(3.913) billion, principally reflecting debt repayments, debt extinguishment costs, and dividends.
- Capital expenditures were $768 million; management expected approximately $750 million of capital expenditures in 2020.
- Cash and cash equivalents were $2.279 billion at year-end, including $869 million held by international subsidiaries.
- Total long-term debt, including the current portion, was $29.238 billion, compared with $31.147 billion at the prior year-end. The company had no commercial paper outstanding and no borrowings under its $4.0 billion revolving credit facility at year-end.
- The company paid $1.953 billion of common-stock dividends in 2019 and declared a subsequent quarterly dividend of $0.40 per share payable March 27, 2020.
Fourth-quarter information
For the fourth quarter of 2019, net sales were $6.536 billion, gross profit was $2.107 billion, net income attributable to common shareholders was $182 million, and diluted EPS was $0.15. The comparable fourth quarter of 2018 included a $12.568 billion net loss attributable to common shareholders, primarily reflecting significant impairment charges.
Material changes versus the prior comparable period
- Underlying results deteriorated despite the return to reported profitability. Adjusted EBITDA declined 13.7% and adjusted EPS declined 18.8%, driven by lower organic sales, higher supply-chain costs, foreign exchange, higher corporate expenses, divestitures, and increased depreciation and amortization.
- U.S. net sales declined 2.0% and Segment Adjusted EBITDA declined 7.8%, reflecting unfavorable volume/mix, procurement and manufacturing cost inflation, strategic investments, and supply-chain losses.
- Canada net sales declined 13.4%, primarily due to divestitures and currency; organic net sales declined 1.9% and Segment Adjusted EBITDA declined 19.9%.
- EMEA net sales declined 6.2%, including currency and divestiture effects; organic net sales declined 1.2% and Segment Adjusted EBITDA declined 8.7%.
- Rest of World net sales declined 14.3%, heavily affected by currency, including Venezuelan bolivar devaluation, and divestitures. Segment Adjusted EBITDA declined 42.8%.
- The company acquired Primal Nutrition for $201 million and completed the sale of Heinz India and certain Canadian natural-cheese assets. These divestitures generated aggregate pre-tax gains of approximately $491 million before other related items.
- Long-term debt was reduced through tender offers, redemptions, and maturities, partly offset by issuance of $3.0 billion of new senior notes. Approximately $405 million of senior notes were repaid on February 10, 2020.
- 2019 restructuring expense was $108 million, compared with $460 million in 2018. Approximately 400 positions were eliminated in 2019, with approximately 550 additional positions expected to be eliminated primarily outside the United States as part of the International-zone reorganization.
Guidance, outlook, risks, contingencies, and unusual items
- Management was conducting an enterprise-strategy review and expected to update its five-year operating plan in 2020. The review could change investment allocations, growth assumptions, reporting units, and the potential portfolio of divestitures.
- Further goodwill or brand impairments remain a significant risk. Goodwill of $35.5 billion and indefinite-lived intangible assets of $43.4 billion remained on the balance sheet. Reporting units and brands with limited excess fair value were identified as especially sensitive to changes in sales, margins, discount rates, growth rates, and royalty rates.
- The company anticipated that a substantial portion of remaining goodwill associated with Latin America Exports and Northeast Asia, carrying amounts of approximately $195 million and $83 million, respectively, could be subject to additional impairment during the first-quarter 2020 reporting-unit reorganization.
- The SEC investigation and related U.S. Attorney’s Office review remained unresolved. The matters concern procurement practices, supplier arrangements, financial reporting, internal controls, disclosures, impairment assessments, and communications with shareholders. Kraft Heinz could not estimate potential liability and disclosed exposure to additional penalties, litigation, professional fees, and regulatory actions.
- The company and current or former officers and directors were defendants in securities, ERISA, and derivative lawsuits. Potential losses could not reasonably be estimated.
- Management and the independent auditor concluded that two material weaknesses in internal control over financial reporting remained: risk assessment and controls over supplier contracts and related arrangements. Disclosure controls were also deemed ineffective. Remediation efforts were ongoing, with additional controls and a contract-management solution planned for 2020.
- Fitch and S&P downgraded the company’s long-term credit rating from BBB- to BB+ on February 14, 2020; Moody’s affirmed Baa3 with a negative outlook. The downgrades could increase borrowing costs and restrict access to commercial paper, although they did not constitute defaults.
- Major operating risks include intense branded and private-label competition, retailer concentration, changing consumer preferences, commodity and energy costs, foreign exchange, Venezuela and other emerging markets, supply-chain disruptions, cybersecurity, product liability, regulatory compliance, and substantial leverage.
- Walmart represented approximately 21% of consolidated net sales in 2019, 2018, and 2017, creating material customer concentration.
- The filing referenced the new coronavirus as a potential source of supply-chain and demand disruption, but it did not provide a quantified financial impact or formal 2020 earnings guidance.
Most important facts for investors to verify
- Whether organic sales, volume/mix, and adjusted EBITDA stabilize or improve after the 2019 declines.
- The outcome of the enterprise-strategy review, 2020 operating plan, segment reorganization, and any resulting impairment tests or divestitures.
- Progress toward remediation and independent validation of the remaining material weaknesses in internal controls.
- The scope and outcome of the SEC and USAO investigations and related securities, ERISA, and derivative litigation.
- Debt maturities, refinancing capacity, covenant compliance, effects of the below-investment-grade ratings, and continued access to commercial paper and capital markets.
- The sustainability of the $0.40 quarterly dividend given leverage, cash flow, rating pressure, and the Board’s discretion over future dividends.
- Whether cash held by foreign subsidiaries is available for U.S. liquidity needs and the potential tax cost of repatriation.
- The accuracy of adjusted metrics relative to GAAP results, particularly because 2019 reported earnings were materially affected by non-cash impairments, divestiture gains, and other unusual items.